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797 F.2d 3 / Page 1
(Cite as: 797 F.2d 3)
United States Court of Appeals,
First Circuit.
Jon SUGARMAN, et al., Plaintiffs, Appellees,
v.
Leonard SUGARMAN and Statler Industries, Inc., Defendants, Appellants.
No. 85-1612.
Argued Feb. 4, 1986.
Decided June 30, 1986.
Minority shareholders filed a derivative action for breach of fiduciary duty and a direct action on a theory of a "freeze-out" by the majority shareholder. The United States District Court for the District of Massachusetts, Bailey Aldrich, Senior Circuit Judge, entered judgment in favor of minority shareholders. Majority shareholder appealed. The Court of Appeals, Coffin, Circuit Judge, held that: (1) the minority shareholders established that the majority shareholder's offer to purchase stock at an inadequate price was part of a plan to freeze the minority shareholders out of the corporation; (2) laches did not bar recovery for years prior to the year in which the suit was instituted; (3) the action could be viewed as a tort action for purposes of calculating interest; and (4) the minority shareholders were not entitled to recover attorney fees.
Affirmed in part, vacated in part and remanded.
West Headnotes
[1] Corporations 190
101k190Most Cited Cases
District court could appropriately conclude that majority shareholder's offer to buy minority shareholder's stock at inadequate price was "capstone" of plan to freeze out minority shareholders once district court found that majority shareholder took some actions that were designed to freeze minority shareholders out of financial benefits that would ordinarily have received from close corporation, even if majority shareholder did not employ every possible device for effecting freeze-out.
[2] Federal Courts 913
170Bk913Most Cited Cases
Erroneous statement that minority shareholders' father died and that no pension was voted to his estate, when in fact father left close corporation's employ in subsequent year was harmless for purposes of determining whether there was differential treatment between majority shareholder's father and minority shareholders' father sufficient to justify finding "freeze-out" of minority shareholders.
[3] Corporations 190
101k190Most Cited Cases
Even if minority shareholders' father and majority shareholder's father were not identically situated within close corporation, their situations were not so disparate as to preclude finding that payments to majority shareholder's father were special treatment for his side of family for purposes of determining whether majority shareholder effected freeze-out of minority shareholders.
[4] Corporations 190
101k190Most Cited Cases
District court could legitimately conclude that majority shareholder's offer of $3.33 per share to minority shareholders for stock in close corporation was unreasonably low and, thus, part of plan to freeze minority shareholders out of corporation, even thoughstock option plan to which court referred in determining fair market value of stock had expired prior to majority shareholder's offer.
[5] Corporations 310(1)
101k310(1)Most Cited Cases
There was nothing improper in reducing level of deference to board of directors in close corporation once district court determined that majority shareholder who controlled board had operated in bad faith in connection with determining whether majority shareholder received excessive compensation which was intended to freeze out minority interests.
[6] Evidence 571(7)
157k571(7)Most Cited Cases
District court was clearly within its discretion in accepting minority shareholders' expert's testimony that he did not include stock option plans in his analysis of whether majority shareholder received excessive compensation because such plans were not common in small companies like close corporation and because his experience was that when officer already had major ownership of company, officer did not participate in long-term incentive plans, and whether that compensation was intended to freeze out minority interests.
[7] Corporations 190
101k190Most Cited Cases
Results of Internal Revenue Service audits that found majority shareholder's compensation to be unreasonable during only two years was not conclusive for purposes of determining whether majority shareholder received excessive compensation from 1978-1984 and whether that compensation was intended to freeze out minority interests in close corporation.
[8] Corporations 190
101k190Most Cited Cases
District court acted well within its discretion in refusing to consider potential sales commissions that majority shareholder could have received instead of salary for purposes of determining whether majority shareholder received excessive compensation from 1978-1984 which was intended to freeze out minority interests.
[9] Federal Courts 914
170Bk914Most Cited Cases
There was no reversible error in district court's calculations about impact of bonus plan which substantially contributed to majority shareholder's salary from 1976-1979 for purposes of determining whether majority shareholder received excessive compensation from 1978-1984 which was intended to freeze out minority interests.
[10] Corporations 190
101k190Most Cited Cases
It was appropriate for district court to question reasonableness of majority shareholder's salary which increased by almost $100,000 per year at time close corporation was doing quite poorly and majority shareholder's bonuses fell off significantly for purposes of determining whether majority shareholder received excessive compensation from 1974-1978 which was intended to freeze out minority interests.
[11] Corporations 190
101k190Most Cited Cases
District court acted within its discretion in making modifications to majority shareholder's compensation to reflect fact that possible compensation was "catch-up" pay for previous years in which majority shareholder may have been underpaid, even though it did not consider all of majority shareholder's higher than usual salaries were justified on grounds of catch-up pay, for purposes of determining whether majority shareholder received excessive compensation from 1978-1984 which was intended to freeze out minority interests.
[12] Corporations 190
101k190Most Cited Cases
Laches did not bar recovery of damages for majority shareholder's offer to purchase stock at inadequate price as part of plan to freeze minority shareholders out of corporation at time when majority shareholder was receiving excessive compensation for all years prior to year before year in which suit was filed where minority shareholder made complaint about majority shareholder's salary at 1978 and 1979 stockholder meetings, and filed suit in 1981.
[13] Interest 31
219k31Most Cited Cases
Massachusetts statute providing that if there is no agreement or provision of law for different rate, interest shall be calculated at rate of 6% did not apply to direct action by minority shareholders on theory of "freeze-out." M.G.L.A. c. 107, § 3.
[14] Interest 31
219k31Most Cited Cases
Direct action by minority shareholders alleging that majority shareholder planned to freeze minority shareholders out of close corporation could be viewed as tort action for purposes of calculating interest on damage award. M.G.L.A. c. 231, § 6B.
[15] Corporations 190
101k190Most Cited Cases
Minority shareholders who successfully maintained direct action against majority shareholder on theory of "freeze-out" were not entitled to attorney fees under shareholders' derivative action exception to general rule that prevailing parties are not entitled to recover counsel fees in absence of statute, court rule enforceable contract or stipulation where shareholders recovered in their personal action and received damages directly, so that there was no "fund" for benefit of all shareholders in corporation.
[16] Corporations 190
101k190Most Cited Cases
Minority shareholders who prevailed in direct action against majority shareholder on theory of "freeze-out" were not entitled to attorney fees under equitable exception to general American rule against awarding attorney fees to prevailing party where record did not indicate that action was exceptional or that there were dominating reasons for awarding attorney fees.
*5 David G. Hanrahan with whom Arthur M. Gilman, David L. Klebanoff and Gilman, McLaughlin & Hanrahan, Boston, Mass., were on brief, for defendants, appellants.
Thomas V. Urmy, Jr. with whom Charles M. Trippe, Jr., Janice Kelley Rowan and Warner & Stackpole, Boston, Mass., were on brief, for plaintiffs, appellees.
Before COFFIN and BOWNES, Circuit Judges, and PETTINE, [FN*] Senior District Judge.
FN* Of the District of Rhode Island, sitting by designation.
COFFIN, Circuit Judge.
Leonard Sugarman appeals from a judgment of the United States District Court for the District of Massachusetts, based on a finding that he breached his fiduciary duty to minority shareholders in a close corporation. We conclude that none of the various errors of fact or law alleged by appellant warrant reversal of the district court's judgment as to liability. Because, however, of our differences with the district court as to the appropriate Massachusetts statute governing interest and the allowability of attorney's fees, we must remand for a recalculation of appellees' award, increasing the amount attributable to interest and deleting the amount attributable to attorney's fees.
I. Factual Background
In 1906, four brothers formed a partnership, Sugarman Brothers, for the purpose of selling paper products. By 1918, the partnership was owned in equal shares and managed by three of the four brothers: Joseph, Samuel and Myer Sugarman. Leonard Sugarman ("Leonard"), defendant-appellant, is the son of Myer, who died in 1983. Plaintiffs-appellees are the grandchildren of Samuel, who died in 1965.
In the 1930's, the principals in Sugarman Brothers organized Leonard Tissue Corporation, *6 owned equally by Joseph, Myer and Samuel. Following World War II, Sugarman Brothers was incorporated, with its stock also owned equally by the three Sugarman branches. In 1964, Leonard Tissue changed its name to Statler Tissue and in 1969, Statler Tissue and Sugarman Brothers merged to create Statler Corporation. Statler's common stock was owned in approximately equal amounts by each of the three Sugarman branches. Leonard, his father Myer, and appellees' father, Hyman, were all officers and directors of the company.
The present difficulties arise from the fact that, after the original equal division which existed until 1974, one branch of the family has controlled a majority of the stock and all of the management. Defendant Leonard Sugarman, president of the company and chairman of the board, owns 61% of the stock; plaintiffs Jon Sugarman, James Sugarman, and Marjorie Sugarman Tyie, Hyman's children, own 21.78%. These disparate holdings result from the fact that Samuel gave some of his stock to his son Hyman, and some to Jon, James and Marjorie, Hyman's children. Hyman, in turn, sold his shares to Leonard in 1974. The stock owned by Joseph Sugarman was ultimately redeemed, and while this did not vary the relative proportion of the stock owned by Leonard vis-a- vis the plaintiffs, it did result in Leonard owning over half of the outstanding shares. When Leonard purchased Hyman's shares in the spring of 1974, Leonard and his immediate family owned 49.6% of the company's outstanding stock. Harris Baseman, the company's lawyer, owned approximately .8%. Because Baseman owed his appointment as company counsel to Leonard, and was Leonard's personal counsel, Leonard effectively controlled the company from that time forward.
Members of the other branches of the family were employed by the company from time to time. The district court found that James Sugarman had never sought to be employed by the company, and that Marjorie Sugarman had sought to be employed, but was not. The court stated that Jon Sugarman was employed from 1974 until his discharge in 1978, but did not rule on whether that discharge was improper, as alleged by Jon.
In 1981, plaintiff-appellees brought suit, alleging that Leonard had abused his fiduciary duty to Statler and to appellees. Count I of the complaint sought a derivative recovery against Leonard on behalf of Statler, alleging that Leonard had caused Statler to pay him excessive salary and bonuses and had engaged in other forms of prohibited self-dealing. Count II sought direct recovery for appellees against Leonard on the theory of "freeze-out" of minority shareholders. This theory was based on allegations that Leonard had deprived Jon and Marjorie Sugarman of desired employment with the company, had drained off the company's earnings in the form of excessive compensation to Leonard, and had refused to pay dividends.
The district court found that Leonard had given his father, Myer, salary and pension benefits that were not given equally to Hyman, appellees' father. In addition, it found that Leonard had offered to buy Jon and Marjorie's stock at a grossly inadequate price. The court also found that Leonard had received excessive compensation from Statler for the years 1978 to 1984 and that this overcompensation "was effected in bad faith, as part of an attempt to freeze out minority interests". The court concluded that this combination of factors was proof of Leonard's effort to improperly freeze appellees out of the company. Adding annual interest at twelve percent from the dates each of these payments were made, the court concluded that a total amount of $1,353,837 had been improperly paid to Leonard and Myer. The court further found that Leonard had improperly caused Statler to pay on his behalf an additional $82,201 in attorney's fees and $9,836 in expert witness fees in defending this action. The court then awarded damages directly to appellees in an amount equal to 21.78% of these improper payments, a percentage equivalent to the amount of stock owned by appellees. The *7 court also awarded appellees their attorney's fees and costs in the amount of $115,720. The final amount awarded to appellees was $537,925.
II. Freeze-Out
We first examine the legal standard that must be met to establish a "freeze- out" of minority shareholders, and then analyze the evidence and findings of the district court. In Donahue v. Rodd Electrotype Co. of New England, 367 Mass. 578, 328 N.E.2d 505 (1975), the Massachusetts Supreme Judicial Court (SJC) held that shareholders in a close corporation owe one another a fiduciary duty of " 'utmost good faith and loyalty' ". 367 Mass. at 593, 328 N.E.2d 505 (quoting Cardullo v. Landau, 329 Mass. 5, 8, 105 N.E.2d 843 (1952)). According to the court, stockholders in a close corporation "may not act out of avarice, expediency or self-interest in derogation of their duty of loyalty to the other stockholders and to the corporation." Id.
The court's decision in Donahue was premised on the rationale that the corporate form of a close corporation "supplies an opportunity for the majority stockholders to oppress or disadvantage minority stockholders". Id. 367 Mass. at 588,328 N.E.2d 505. Some of these devices to "freeze out" the minority were described by the court:
" 'The squeezers [those who employ the freeze-out technique] may refuse to declare dividends; they may drain off the corporation's earnings in the form of exorbitant salaries, and bonuses to the majority shareholder-officers and perhaps to their relatives ...; they may deprive minority shareholders of corporate offices and of employment by the company; they may cause the corporation to sell its assets at an inadequate price to the majority shareholders.' " Id. at 588-89, 328 N.E.2d 505, (quoting F.H. O'Neal and J. Derwin, Expulsion or Oppression of Business Associates: "Squeeze-Outs" in Small Enterprises 42 (1961)).
All of these devices are designed to ensure that the minority shareholders do not receive any financial benefits from the corporation. When these types of "freeze-outs" are attempted by the majority, "the minority stockholders, cut off from all corporation-related revenues, must either suffer their losses or seek a buyer for their shares". 367 Mass. at 590-91, 328 N.E.2d 505. This, according tothe court, is often "the capstone of the majority plan". Because minority shareholders cannot sell their stock on the open market, as can shareholders in public corporations, the minority shareholders may be compelled to deal with the majority and be vulnerable to low offers for their stock. Id. at 592, 328 N.E.2d 505. As the court explained, "[w]hen the minority stockholder agrees to sell out at less than fair value, the majority has won." Id.
In Wilkes v. Springside Nursing Home, Inc., 370 Mass. 842, 353 N.E.2d 657 (1976), the SJC held that three directors of a close corporation had improperly "frozen-out" Wilkes, a fourth director when they removed him from the payroll without any "legitimate business interest". 370 Mass. at 852, 353 N.E.2d 657. The court also stated that it could "infer that a design to pressure Wilkes into selling his shares to the corporation at a price below their value well may have been at the heart of the majority's plan." Id.This inference arose from the fact that "Connor [one of the stockholders], acting on behalf of the three controlling stockholders, offered to purchase Wilkes's shares for a price Connor admittedly would not have accepted for his own shares." Id. at 852, n. 14, 353 N.E.2d 657.
In these cases, the SJC has pioneered in developing an effective cause of action for minority shareholders who have been denied their fair share of benefits in close corporations. At the same time, it has carefully set out the contours of that cause of action. First, it is not sufficient for a minority shareholder to prove that the majority shareholder has taken excessive compensation or other payments from the corporation. See Bessette v. Bessette, 385 Mass. 806, 809-10 & n. 5,*8434 N.E.2d 206 (1982) (right to recover overcompensation payments belongs to the corporation as a whole; suit must be brought as derivative action unless plaintiffs specifically allege that "defendant's conduct was an attempted 'freeze-out' of the minority stockholders by draining off 'the corporation's earnings in the form of exorbitant salaries and bonuses.' ") (quoting Donahue, 367 Mass. at 588-89, 328 N.E.2d 505). Here, appellees alleged a freeze-out attempt, and the district court found that Leonard's overcompensation was indeed "effected in bad faith, as part of an attempt to freeze out minority interests".