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Massachusetts SJC Rules on Fiduciary Duties Owed to and By Shareholder-Employee in Closely Held Corporation

A recent decision by the Massachusetts Supreme Judicial Court (SJC), Selmark Associates v. Ehrlich, illustrates the complex web of fiduciary obligations owed to and by shareholder-employees in a closely held corporation under Massachusetts law. The SJC upheld a jury verdict that a closely held corporation’s majority stockholder (and that stockholder’s sole owner) breached their fiduciary duties to a minority stockholder when they terminated his employment without a legitimate business purpose and without considering less harmful alternative steps. But the court also upheld the jury’s verdict that the terminated employee breached his fiduciary duties to the corporation when, while still a stockholder, he solicited the corporation’s customers on behalf of his new employer. The case serves as a reminder that fiduciary obligations may be implicated in any action involving shareholder-employees of a closely held corporation.

Massachusetts has long held that shareholders in a closely held corporation owe fiduciary duties to each other and to the corporation. Closely held corporations are typified by (1) a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation. The Massachusetts courts have reasoned that this structure resembles a partnership, and therefore the same fiduciary duties of utmost good faith and loyalty should apply among shareholders in a closely held corporation as among partners in a partnership. These fiduciary duties restrict the closely held corporation’s treatment of shareholder-employees. But by the same token, shareholder-employees are also bound by a duty of loyalty to the corporation and their fellow shareholders.

These fiduciary duties may be partially displaced by properly adopted shareholder agreements that specifically address particular issues. For example, an employment agreement may define the terms of a shareholder’s employment. But as the SJC made clear in Selmark Associates, the existence of a contract does not completely relieve shareholders of their fiduciary duties to one another, and a claim for breach of fiduciary duty may still be brought if the contract does not entirely govern the parties’ rights and obligations.

All of these issues came up in Selmark Associates. While the shareholder-employee (Ehrlich) had once been subject to an employment agreement with the corporation (Marathon), the agreement had expired before he was fired, and consequently general fiduciary duties applied. The SJC held that there was sufficient evidence to support a verdict that the majority stockholder (Selmark) and its principal breached their duty to Ehrlich by terminating him without a legitimate business purpose and without considering alternatives.

But the SJC also held that the shareholder-employee violated his fiduciary duties when, after his termination, he solicited the corporation’s customers on behalf of his new employer. At the time, Ehrlich still owned Marathon stock and therefore he still owed a duty of loyalty to Marathon. Even though his termination had been wrongful, that did not extinguish his fiduciary duty as a shareholder to Marathon, the SJC held. “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,” the court observed.

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Chip Phinney