Shareholder Duties And Their Effect On Succession Planning For Closely-Held Massachusetts Corporations
By Marc C. Laredo

When a business has only one owner, it tends to be simpler to run - one person is in charge; decisions can be made without consulting others; and the owner can treat the business as something that he or she owns completely. Once a business has multiple owners, a common result of a succession plan, things change. When the multiple owners are shareholders in a corporation, a new set of considerations will come into play - shareholder duties.

Shareholders in closely-held Massachusetts corporations owe one another a strict fiduciary duty. This means that shareholders must treat each other fairly and be loyal to one another and to the company. These fiduciary duties apply to all shareholders in a closely-held Massachusetts corporation, even to shareholders who own only a small amount of stock.

Consider how those rules apply to the following situation. The successful founder and sole shareholder of a Massachusetts manufacturing company creates a succession plan that transfers his 100 shares of stock in the company as follows:

• 40 shares to his daughter who serves as the company's vice president of sales;
• 40 shares to his son who is an elementary school teacher and is employed by the business part-time while collecting a large salary; and
• 20 shares to the company's long-time vice president of manufacturing.

There are no agreements among the shareholders or between the shareholders and the corporation.

Two years later, the following events have occurred:

• the daughter, who has assumed the role of company president, fires her brother;
• the vice president of manufacturing learns of another manufacturing opportunity and secretly sets up his own company to take advantage of it; and
• the company offers to buy her brother's stock in the company but makes no offer for the vice president of manufacturing's stock.

As a result, each of the shareholders has hired an attorney to prepare for litigation.

A shareholder can breach his or her fiduciary duty - the obligation to treat every other shareholder as a partner - in any number of ways. For instance, he or she might:

• act in a manner that is harmful to the interests of other shareholders (such as the daughter firing her brother);
• acquire or divert a corporate business opportunity for his personal profit (the vice-president's setting up his own company); or
• cause the company to buy stock from one shareholder but not make the same offer to other shareholders (the daughter having the company only make an offer to her brother).

Each of the problems in the example could have been avoided, or at least anticipated. The fundamental principles that must be adhered to are simple: fairness and disclosure.

For example, an act that may be harmful to a minority shareholder will withstand a challenge from the minority shareholder (1) if the majority shareholder can show that there is a legitimate business purpose for the act and (2) no practical alternatives which are less harmful to the minority shareholder are available. Thus, the daughter can fire her brother if she can show that it was for poor performance and there was no other reasonable alternative available to her. Of course, this task would have been easier had there been an employment contract.

Likewise, a shareholder can take and use a corporate opportunity if he follows the proper procedure. Before diverting a corporate opportunity for his or her own use, a shareholder must fully disclose that opportunity to the corporation. Nondisclosure, in and of itself, is a breach of fiduciary duty. If the corporation approves of the shareholder's action or if the corporation would be unable to avail itself of the opportunity, the shareholder's action will probably withstand a legal challenge.

Finally, the issue of control could and should have been resolved in advance by an agreement among the shareholders. An agreement to purchase stock, for example, even if the price is less than market value, generally is enforceable if the agreement was entered into by all shareholders in advance.

Whenever a corporation has more than one shareholder, the shareholders must act in a manner that is fair and reasonable to one another. When a corporation's succession plan calls for a transfer of ownership to multiple owners, careful planning can go far to help ensure a smooth transition.

Please Note: The purpose of this article is to provide general information about legal developments and should not be used as a substitute for professional advice on your particular legal situation.

Copyright © 2003 Laredo & Smith, LLP. All rights reserved.