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May 20‚ 2011
Shareholder Agreements in Closely Held Massachusetts
Corporations
By Elizabeth B. Burnett
and Jehanne M. Bjornebye
Can fiduciary duties trump contractual rights of shareholders
in closely held companies? Are shareholders of a subchapter-S corporation
entitled to sell their shares to third parties, even when that sale would
destroy the corporation’s subchapter-S status? These are the questions
addressed in the recent Superior Court decision Merriam v. Demoulas
Super Markets, Inc.,1
and lawyers who draft shareholder and employment agreements for closely
held corporations should take note of the court’s guidance.
Merriam marks yet another chapter in the ongoing
infighting among Demoulas shareholders. The dispute centered on the
shareholders’ right to sell stock when that sale would cause the
corporation to lose its favorable subchapter-S status. One Demoulas faction
argued that fiduciary duties prohibited such a sale, even though nothing in
the corporate charter prohibited it, citing to A.W. Chesterton Company
v. Chesterton.2 The
would-be selling shareholders disagreed, arguing that their contractual
right to sell company stock was not restricted by their fiduciary duties,
citing to Chokel v. Genzyme Corporation.3
Merriam held that when shareholder conduct “falls
clearly within the scope of” articulated contract rights, fiduciary duties
do not restrict shareholders’ exercise of their contract rights, but that
fiduciary duties can serve as a check on shareholder conduct when
shareholders act “in a manner inconsistent with the express terms of a
shareholder agreement.” In either situation, Merriam held that
contracts between shareholders are subject to the implied covenant of good
faith and fair dealing.
Although Merriam
did resolve some of the underlying tension in Massachusetts law between
fiduciary duties and contract rights,4
the court’s renewed emphasis on the implied covenant of good faith and fair
dealing creates murky waters for practitioners crafting contracts for
closely held companies. Under Massachusetts law, that covenant requires
that contracting parties remain faithful to the intended and agreed
expectations of the contract; a breach is found where one party violates
the reasonable expectations of another. When drafting contracts between
shareholders of closely held companies, including corporate charters,
employment agreements, or shareholder agreements, practitioners should take
care to clearly establish the parties’ rights and obligations, to
unambiguously define any restrictions on those rights, and to expressly
memorialize the parties’ expectations. Failure to do so could result in
interpretations of these contracts in which fiduciary duties trump contract
rights and pave the way for claims for breach of the implied covenant of
good faith and fair dealing which allege “reasonable expectations” of
parties that were never intended.
If you have any questions or would like more information
about this advisory, please contact the authors or your Mintz Levin
attorney.
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1 Merriam v. Demoulas Super
Markets, Inc., Civ. A. No. 10-02681 (Mass. Super. Ct. Mar. 29, 2011)
(Haggerty, J.).
2 A.W. Chesterton Co., Inc.
v. Chesterton, 128 F.3d 1 (1st Cir. 1997).
3 Chokel v. Genzyme Corp.,
449 Mass. 272 (2007).
4 Pointer applied
fiduciary duty principles, and not contract law, to the employment
termination of a minority shareholder based on its finding that the
employment contract permitted termination only upon a violation of the
employment contract, and there was no finding of such a violation. Pointer
v. Castellani, 455 Mass. 537 (2009). Blank applied the implied
covenant of good faith and fair dealing, and not fiduciary duties, to the
termination of a minority shareholder/employee because the employment
contract permitted termination without cause. Blank v. Chelmsford
OB/GYN, P.C., 420 Mass. 404 (1995). Merriam reconciled these two
seemingly inconsistent Supreme Judicial Court employment termination cases
involving closely held corporations when it held that “fiduciary duties may
still govern where shareholders act in a manner inconsistent with the
express terms of a shareholder agreement [as in Pointer], but that
courts will not entertain fiduciary claims where a shareholder’s action
falls clearly within the scope of an agreement [as in Blank].
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