Massachusetts Business Attorney · Business Law
In a small company, the owners are often family members, friends or former coworkers. When that relationship breaks down, a minority owner can find that there is no market for their shares, the majority controls the board, and the paycheck can stop overnight.
Massachusetts law answers that problem with a strong fiduciary duty among the owners of closely held businesses. Here is where that duty comes from, how it applies to LLCs, and what remedies and deadlines matter.
What is a fiduciary duty in a business context?
A fiduciary must act in the interest of another rather than their own. Directors and officers owe fiduciary duties to the company. In Massachusetts, owners of a closely held business can also owe fiduciary duties directly to each other.
The leading case is Donahue v. Rodd Electrotype Co. (1975). The Supreme Judicial Court (SJC) held that stockholders in a close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another. The court described that duty as one of “utmost good faith and loyalty,” and said such stockholders may not act out of avarice, expediency or self-interest in derogation of their duty of loyalty. The court described a close corporation as one with a small number of stockholders, no ready market for the stock, and substantial majority stockholder participation in management.
In Donahue itself, the controlling family caused the corporation to buy back shares from the retiring controlling stockholder but refused to buy the minority holder’s shares at the same price. The SJC held that when a close corporation buys shares from a controlling stockholder, it must offer all stockholders an equal opportunity to sell a proportionate number of their shares at the same price.
The Wilkes balancing test
A year later, the SJC recognized that applying the Donahue standard without limits could hamper legitimate decisions by those running the business. In Wilkes v. Springside Nursing Home, Inc. (1976), the court adopted a balancing approach that Massachusetts courts still use:
- When a minority owner alleges a breach, the controlling group may show a legitimate business purpose for its action.
- If it does, the minority owner may still prevail by showing that the same legitimate objective could have been achieved through an alternative course less harmful to the minority’s interest.
- The court then weighs the legitimate business purpose against the practicability of the less harmful alternative.
In Wilkes, a founding stockholder was removed from the payroll and not re-elected as a director or officer, without any showing of misconduct on his part. The SJC found that the majority had breached its fiduciary duty.
Common forms of breach
Every case turns on its facts, but several patterns come up again and again in closely held businesses.
Freeze-outs
A freeze-out happens when those in control use their power to deprive a minority owner of the benefits of ownership, for example by firing the minority owner from a job that was part of the deal, removing them from the board, cutting off information, or stopping dividends while paying the controlling owners through salaries. Wilkes was a freeze-out case.
Self-dealing
Self-dealing covers transactions in which a fiduciary stands on both sides, such as excessive compensation, above-market rent paid to an owner, or steering company business to an entity an owner controls.
Diversion of corporate opportunities
In Demoulas v. Demoulas Super Markets, Inc. (1997), the SJC addressed the corporate opportunity doctrine. A director or officer may not take for themselves a business opportunity that belongs to the company unless the opportunity is first offered to the company and rejected. The fiduciary must fully disclose all material facts about the opportunity. If the fiduciary does not make that disclosure, the fiduciary bears the burden of proving that their actions were intrinsically fair to the company.
Whether something is a company opportunity can depend on the governing documents. In Pointer v. Castellani (2009), the SJC found no corporate opportunity where the company’s operating agreement stated a limited business purpose and allowed members to carry on other business activities.
The duty runs both ways
The duty is not limited to majority owners. In Smith v. Atlantic Properties, Inc. (1981), four stockholders each held 25 percent, and the corporate documents required an 80 percent vote for corporate action, giving each an effective veto. One stockholder used his veto to block dividends, and the corporation was assessed tax penalties for accumulating earnings. The Appeals Court held that a minority stockholder with that kind of veto power is bound by the same duty of utmost good faith and loyalty, and had breached it. Any owner with real power over a closely held business should assume the duty applies to them.
Do these duties apply to LLC members?
Many small Massachusetts businesses are organized as limited liability companies under G.L. c. 156C, not as corporations. The statute does not spell out a full set of member duties. Instead, § 63 recognizes that, to the extent members or managers have duties at law or in equity, including fiduciary duties, those duties may be expanded or restricted by the operating agreement. It also provides that a member or manager who relies in good faith on the operating agreement is not liable for that reliance.
Massachusetts courts have applied the close corporation principles to LLCs in cases like these:
- In Pointer v. Castellani (2009), the business was an LLC. It was uncontested that the company was a close corporation, and the SJC applied the Donahue and Wilkes framework. The court upheld the finding that the other members froze out a member who was also the company’s president when they secretly hired a replacement and then fired him.
- In Allison v. Eriksson (2018), the SJC addressed an LLC merger used to squeeze out a minority member. The court concluded that the controlling member acted in bad faith and violated his fiduciary duties, and held that the statutory remedy for dissenting members was not exclusive where the merger was not carried out in compliance with the statute. Trial courts have discretion to fashion equitable relief in that situation.
Because each LLC’s operating agreement is different, how these duties apply to a particular LLC is a question to review with counsel.
What about your operating agreement?
For an LLC, the operating agreement is often the first document to read. Under § 63, it can expand or restrict fiduciary duties, and it can address the situations that lead to disputes: removal of members, outside business activities, buyouts and deadlocks. As Pointer shows, its terms can decide whether conduct was a breach at all. Read it closely, though: a general clause may not reach the specific conduct at issue. If you are forming an LLC or revisiting an existing agreement, see our article on the operating agreement in a Massachusetts LLC.
How to prove a breach
A claim generally requires showing that a duty existed, that it was breached, and that the breach caused harm. The key evidence is usually the governing documents, financial records, meeting minutes, and the owners’ own emails and messages. Under Wilkes, expect the controlling group to offer a business reason, and much of the case may turn on whether a less harmful option was available.
Direct or derivative claim?
An important early question is who was harmed. If the injury is to the company itself, such as a diverted opportunity or money taken from the business, the claim generally belongs to the company and is brought as a derivative claim on its behalf. Demoulas was a derivative action. If the injury is to the owner personally, such as being frozen out of employment or denied an equal opportunity to sell shares, the owner may have a direct claim.
For corporations, derivative claims carry procedural requirements. Under G.L. c. 156D, § 7.42, a shareholder may not start a derivative proceeding until a written demand has been made on the corporation to take suitable action and 90 days have passed, unless the demand has been rejected or waiting would cause irreparable injury to the corporation. For LLCs, the operating agreement and Chapter 156C may set different rules about who may sue on the company’s behalf.
What remedies can you get?
Remedies depend on the claim and the harm. Options recognized in Massachusetts cases include:
- Damages for losses caused by the breach, such as lost compensation or withheld distributions.
- Disgorgement and constructive trust. In Demoulas, the SJC confirmed that gains a fiduciary obtains through a breach may be held for the benefit of the company, and that property diverted in breach of duty may be held in constructive trust.
- Equitable relief, including injunctions to stop ongoing misconduct. In Allison, the SJC recognized trial court discretion to fashion equitable relief for a frozen-out LLC member.
- Restoring the owner’s position. In a freeze-out, the goal is to put the minority owner where they would have been had the freeze-out not occurred, measured by their reasonable expectations.
A court-ordered buyout is not automatic. In Brodie v. Jordan (2006), the SJC held that ordering the majority to buy out a frozen-out minority holder was an improper remedy on those facts, because it put the minority holder in a better position than she would have been in absent the wrongdoing. In Pointer, the SJC applied Brodie and set aside a forced sale. A buyout may still result from a negotiated settlement, a buy-sell agreement or the governing documents. Where the relationship cannot continue, dissolution may also be an option; see our article on how to dissolve an LLC in Massachusetts.
Is Chapter 93A available?
Owners sometimes hope to add a claim under Chapter 93A, the unfair and deceptive practices statute, because it allows multiple damages and attorney’s fees. Disputes among owners of the same business generally fall outside it. In Szalla v. Locke (1995), the SJC held that a dispute between people forming a single business venture was not covered by Chapter 93A.
Why timing matters
Tort claims in Massachusetts, including breach of fiduciary duty, generally must be brought within three years after the cause of action accrues (G.L. c. 260, § 2A). When a claim accrues can be disputed. In Demoulas, the SJC explained that a fiduciary’s failure to disclose is treated as equivalent to fraudulent concealment under G.L. c. 260, § 12, and that an actual knowledge standard applies to a plaintiff relying on that failure, rather than the ordinary reasonableness-based discovery rule. Contract and other related claims have their own limitations periods. Beyond the legal deadline, delay has practical costs: records get lost and money moves.
Frequently asked questions
Can a minority owner breach a fiduciary duty?
Yes. In Smith v. Atlantic Properties, Inc. (1981), the Appeals Court held that a minority stockholder who used a veto power to block corporate action was bound by the duty of utmost good faith and loyalty and breached it.
Can my operating agreement eliminate fiduciary duties?
Under G.L. c. 156C, § 63, an operating agreement can expand or restrict the duties of LLC members and managers. How far a particular clause reaches depends on its wording and the conduct at issue, so the agreement should be reviewed carefully.
How long do I have to sue for breach of fiduciary duty?
Generally three years after the claim accrues under G.L. c. 260, § 2A. When a fiduciary failed to disclose the wrongdoing, the clock may not start until the plaintiff has actual knowledge, under the rule described in Demoulas.
Getting help with a business ownership dispute
Whether you believe you have been frozen out or you control a business and want to act without inviting a claim, the analysis starts with the governing documents and the facts. Learn more about our Massachusetts business law services, or contact our office at 978-273-8337.
About the Author
Richard Alan Gaudet, Esq. is a Massachusetts attorney at the Law Offices of Richard Alan Gaudet, LLC in Middleton, Massachusetts, who advises business owners on formation, operating agreements, ownership disputes and commercial litigation. His practice focuses on professional license defense, business law and litigation, family law, and landlord representation, serving clients across Northern, Eastern, and Central Massachusetts. Reach him at 978-273-8337 or rgaudet@gaudetlawoffice.com. Office: 35 Village Rd., Ste 100, Middleton, MA 01949.
ABOUT THIS ARTICLE
This article was prepared by a Massachusetts attorney and is provided solely for general informational and educational purposes directed to members of the general public. It does not constitute legal advice and does not create an attorney-client relationship. The law applicable to any particular situation depends on the specific facts and circumstances of that matter. Readers are encouraged to seek the advice of a licensed Massachusetts attorney before taking any action.
