Opinion
SUCV2017001BLS1
09-08-2017
Joseph O'Donnell v. Bert B. Davidson, Jr. et al
Filed September 11, 2017
MEMORANDUM AND ORDER ON DEFENDANTS' MOTION TO DISMISS
Edward P. Leibensperger, Justice
In this action by a minority shareholder against the majority shareholders of a closely-held corporation, defendants move to dismiss on the ground that all of plaintiff's claims must be brought as a derivative action on behalf of the corporation. The motion will be allowed, in part, and denied, in part, as described below.
BACKGROUND
The following facts are taken from the First Amended Complaint (" FAC" ).
Plaintiff, Joseph O'Donnell, is the holder of 400 shares of Davidson Hubeny Brands, Inc. (" DH Brands" ), a Massachusetts corporation. O'Donnell's shares constitute 5% of the issued and outstanding shares of DH Brands.
Defendants, Bert B, Davidson and Jeremiah S. Hubeny, each own 2,800 shares of DH Brands. The 2,800 shares constitute 35% of the issued and outstanding shares of DH Brands. Davidson is the president of DH Brands and Hubeny is the treasurer and secretary of the company. Davidson and Hubeny are both directors of DH Brands. At relevant times, until November 2014, Davidson and Hubeny were the only directors, On a date " shortly after" November 21, 2014, a third director was elected.
DH Brands is a closely-held corporation formed in 1988. In addition to the 70% of shares owned collectively by Davidson and Hubeny, approximately seven other individuals, including O'Donnell, own or owned shares. It is alleged that Davidson and Hubeny as majority shareholders, directors and officers of DH Brands control the management, direction and operations of the company. There is no ready market for the shares of DH Brands.
DH Brands' financial statement for the fiscal year ended June 30, 2014 described " related party transactions." The financial statement disclosed that DH Brands paid management services costs of over $1.7 million and commissions of over $1.8 million to a company owned by the two majority stockholders. O'Donnell avers that while he had received " limited disclosure" of payments by DH Brands for management service costs and commissions to a marketing and management company owned by Davidson and Hubeny, he received no details of the transactions or explanation of why the costs were being incurred.
In September 2014, Davidson and Hubeny offered to purchase the shares of non-active shareholders, including the shares owned by O'Donnell. The offer calculated a purchase price based on the income and cash flow of the company discounted by the lack of marketability of the minority shares and the lack of control of the business by the minority shareholders. O'Donnell alleges that the offer did not disclose that the company's expenses were vastly overstated because Davidson and Hubeny had been diverting the profits of the company by paying fees and commissions to another company owned solely by Davidson and Hubeny. The diversion of profits also allegedly caused DH Brands to be unable to pay dividends to shareholders.
O'Donnell responded to the September 2014 offer by letter dated July 15, 2015. O'Donnell requested additional information from the company, particularly concerning the related party transactions, in order to evaluate the offer. In response, Davidson, Hubeny and the company withdrew the offer. O'Donnell contends that the withdrawal of the offer was a " punitive" response to his request for information.
O'Donnell continued to seek financial information from DH Brands but was denied satisfactory responses by Davidson and Hubeny. Based on the limited information that he has received, O'Donnell asserts that Davidson and Hubeny diverted millions of dollars to their solely owned company, defendant Davidson Hubeny Companies, Inc. (" DH Companies" ), that should belong to DH Brands and its shareholders.
The FAC asserts claims in three counts. Count I is a claim of breach of fiduciary duty by Davidson and Hubeny. O'Donnell alleges that the diversion of commissions and management services fees from DH Brands to DH Companies is unnecessary and constitutes an appropriation of a corporate opportunity belonging to DH Brands. With respect to the September 2014 offer to purchase O'Donnell's shares, O'Donnell claims that Davidson and Hubeny utilized financial information reflecting the effect to DH Brands of the unlawful diversion to calculate an artificially low offer price. Finally, O'Donnell complains that the offer was withdrawn as a punitive measure because he asked questions regarding the financial transactions.
Count II of the FAC alleges that Davidson and Hubeny supplied O'Donnell with false information in an effort to induce him to sell his shares. Count III of the FAC alleges that DH Companies aided and abetted Davidson and Hubeny in their breaches of fiduciary duties.
The FAC does not allege that O'Donnell acted in reliance on any misrepresentations by defendants. O'Donnell did not sell his shares. He remains a minority shareholder of DH Brands.
DISCUSSION
A motion to dismiss for failure to state a claim upon which relief may be granted under Mass.R.Civ.P. 12(b)(6) permits " prompt resolution of a case where the allegations in the complaint clearly demonstrate that the plaintiff's claim is legally insufficient." Harvard Crimson, Inc. v. President & Fellows of Harvard Coll., 445 Mass. 745, 748, 840 N.E.2d 518 (2006). To survive a motion to dismiss, a complaint must set forth the basis for the plaintiff's entitlement to relief with " more than labels and conclusions." Iannacchino v. Ford Motor Co., 451 Mass. 623, 636, 888 N.E.2d 879, quoting Bell A. Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). At the pleading stage, Mass.R.Civ.P. 12(b)(6) requires that the complaint set forth " factual 'allegations plausibly suggesting (not merely consistent with)' an entitlement to relief . . ." Id., quoting Bell A. Corp., 550 U.S. at 557. The court must, however, accept as true the allegations of the complaint and draw every reasonable inference in favor of the plaintiff. Curtis v. Herb Chambers I-95, Inc., 458 Mass. 674, 676, 940 N.E.2d 413 (2011).
As a threshold matter, O'Donnell is not able to sustain a claim for misrepresentation in connection with the offer to purchase his shares. O'Donnell did not rely on the alleged misrepresentation because he did not accept the offer. O'Donnell still owns 400 shares of DH Brands. As a result, Count II must be dismissed.
The more substantive issue presented is whether the claim for breach of fiduciary duty in Count I of the FAC must be asserted solely in a derivative action. O'Donnell concedes that he does not assert a derivative action and, apparently, has not taken the steps required by G.L.c. 156D, § 7.42 in order properly to assert a derivative claim on behalf of DH Brands.
Read liberally, the FAC alleges that the majority shareholders schemed to divert money out of DH Brands to themselves. Their alleged scheme may be characterized as the majority shareholders paying excessive compensation, usurping a corporate opportunity or diverting to themselves " profits to which all shareholders of the Company, including O'Donnell, should have been entitled according to their respective ownership interest." FAC, P1.
The Supreme Judicial Court in Bessette v. Bessette, 385 Mass. 806, 434 N.E.2d 206 (1982), provided guidance as to when a breach of fiduciary duty by a director or majority shareholder gives rise to a personal action by a minority shareholder. Acknowledging that shareholders in a close corporation owe one another fiduciary duties, Donahue v. Rodd Electrotype Co., 367 Mass. 578, 593, 328 N.E.2d 505 (1975), the Court noted that " our holding in Donahue applies if '[i]t would be difficult for the plaintiff . . . to establish breach of fiduciary duty owed to the corporation . . .'" Bessette, 385 Mass. at 809, citing Donahue at 589, n.14. In other words, if the minority shareholder suffers a harm unique to himself, as in Donahue, he may sue directly. But if the harm perpetrated by the majority is suffered by the corporation, the remedy is a derivative action on behalf of the corporation. The Court concluded that " [i]t is a basic principle of corporate law that if a majority stockholder receives corporate cash distributions and a salary in excess of the reasonable value of services rendered, the right to recover the overpayments belongs to the corporation." Bessette, 385 Mass. at 809. The direct action by the minority shareholder in Bessette was dismissed. Id. at 810.
In Crowley v. Communications for Hospitals, Inc., 30 Mass.App.Ct. 751, 573 N.E.2d 996 (1991), the minority shareholder asserted both direct and derivative claims. The claims, like the claims asserted by O'Donnell here, were that the majority caused the corporation to pay excessive compensation to themselves, failed to pay dividends, and attempted to purchase the minority's shares at a bargain price. Id. at 762. The conduct by the majority was alleged to be a " freeze-out" directed to the minority shareholder.
The Appeals Court in Crowley held that relief was available to the minority shareholder through his derivative claim, not his direct claim. Id. at 766. " [W]here corporate recovery for misdeeds by a corporate fiduciary is available under traditional corporate law, and such recovery provides a just measure of relief to the complaining stockholder, resort to direct, personal action against miscreant fiduciaries may not be available even when the acts complained of may be seen as a freeze-out scheme." Id. at 765. As a remedy for the successful derivative claim, the Court required the company, after obtaining reimbursement from the wrongdoers, to pay a dividend to all shareholders. Id. at 767.
O'Donnell points to a more recent case from the Supreme Judicial Court in support of his argument for a direct action. In Brodie v. Jordan, 447 Mass. 866, 857 N.E.2d 1076 (2006), a minority shareholder alleged an illegal freeze-out by majority shareholders. The Court held that it was " useful" to analyze the plaintiff's claim in terms of the " reasonable expectations" of the minority shareholder. Id. at 869-70. The trial court found that the reasonable expectations of the plaintiff in Brodie of benefits from owning one-third of the shares of the close corporation at issue were interfered with " by excluding her from corporate decision-making, denying her access to company information, and hindering her ability to sell her shares in the open market." Id. at 870. The plaintiff also claimed that the majority shareholders were the only ones receiving any financial benefit from the corporation. The plaintiff sought an order requiring the corporation to buy her shares at a fair price. The trial court found breach of fiduciary duty with respect to claims asserted by the plaintiff directly, not derivatively, against the majority shareholders.
The Supreme Judicial Court did not address whether the plaintiff in Brodie was required to bring her claims derivatively on behalf of the corporation. The Court noted that the question of liability was not before it. " [T]he only question before us is whether, on this record, the plaintiff was entitled to the remedy of a forced buyout of her shares by the majority." Id. The Court held in Brodie that the minority shareholder was not entitled to a buyout under Massachusetts law governing a close corporation. Id. at 872.
The majority shareholders appealed the finding of liability by the trial court to the Appeals Court. which affirmed the trial court. Brodie v. Jordan, 66 Mass.App.Ct. 371, 384, 847 N.E.2d 1125 (2006). The majority shareholders did not seek further appellate review of that finding. The Appeals Court held that the " conclusion that the defendants were in breach of their fiduciary duty to Brodie is neither clearly erroneous nor inconsistent with the relevant legal standard." Id. There is no discussion in the decision regarding whether some or all of plaintiff's claims could or should have been brought as derivative claims.
Whether O'Donnell's claims are direct or derivative is determined by what is, and what is not, alleged in the FAC. The relief O'Donnell seeks in the FAC is (a) " damages proved at trial," and (b) an " Order [to] Davidson and Hubeny to redeem O'Donnell's shares at the fair market value as determined by this Court." FAC, p. 11.
O'Donnell's claim for damages fails as a direct claim. If there has been an unlawful diversion of money or opportunity away from DH Brands, the harm is to the corporation, not O'Donnell, individually. A derivative action is an available remedy to DH Brands. See Crowley, 30 Mass.App.Ct. at 765 ( even if there are elements of a freeze-out, action for recovery of excessive compensation must be brought as derivative action). O'Donnell's personal claim for damages as a result of alleged wrongdoing by the majority shareholders must be dismissed.
O'Donnell's prayer for an order to the majority shareholders to redeem O'Donnell's shares requires analysis of what O'Donnell's reasonable expectations were as a minority, 5%, shareholder in DH Brands. Where a minority shareholder in a close corporation is deprived of the economic benefit of his ownership by unlawful action of the majority a personal claim of " freeze-out" may arise. Brodie, 447 Mass. at 870. See e.g., Wilkes v. Springside Nursing Home, Inc., 370 Mass. 842, 854, 353 N.E.2d 657 (1976) (expectation of employment). Here, however, O'Donnell does not plead, like the plaintiff in Brodie, that he had an expectation, as a minority shareholder, of employment by the company or as an officer or director. The FAC does not even explicitly allege a " freeze-out" as described in Brodie or Crowley.
That said, however, defendants did create a reasonable expectation personal to O'Donnell. They offered to buy his shares at a price that, pursuant to their fiduciary duties, was required to have been based upon full and complete information. The FAC alleges that when O'Donnell sought information in order to evaluate the offer, he was denied complete information. The offer was then withdrawn. Moreover, as described, the FAC alleges that defendants' offer to buy O'Donnell's shares was knowingly unfair and misrepresented the actual state of the company. Those allegations state a claim for breach of fiduciary duty directly to O'Donnell.
Defendants argue that because no transaction for the purchase of O'Donnell's shares was consummated, O'Donnell has suffered no harm. But that argument ignores the expectations created by defendants by making the offer. O'Donnell was harmed by the alleged failure to provide him with complete financial information so he could evaluate the offer. Had he received the information requested, he alleges that he would have been able to participate in negotiations to sell his shares. While refusing to purchase a minority shareholder's stock is not a breach of fiduciary duty, Goode v. Ryan, 397 Mass. 85, 87-88, 489 N.E.2d 1001 (1986), the record on this motion to dismiss is insufficient to conclude as a matter of law, that had there not been a breach of fiduciary duty, O'Donnell still would have rejected the offer. O'Donnell lost the opportunity to engage with defendants to sell his shares in an open and fair transaction.
What remedy may be available to O'Donnell on his direct claim is another question. In general, potential remedies should await a full exposition of the facts at trial or, perhaps, on summary judgment. Brodie stands for the proposition that, absent a bylaw or other corporate agreement, the court has no authority to order defendants or DH Brands to purchase O'Donnell's shares at a determined price. That remedy would put O'Donnell " in a significantly better position than [he] would have enjoyed absent the wrongdoing, and [would] well exceed[ed] [his] reasonable expectations of benefit from [his] shares." Brodie, 447 Mass. at 872 (emphasis in original). Nevertheless, the Court in Brodie remanded the case for an evidentiary hearing for the court to determine a remedy that would vindicate the plaintiff's interests. Id. at 873. Among the remedies the Court listed as a possible remedy was " the propriety of compelling the declaration of dividends." Id. at 874. At minimum, it would seem that there is a potential remedy of requiring full disclosure by the majority of the details of the related party transactions. Because O'Donnell pleads a direct claim arising from the expectation, created by defendants, of a fair valuation of his shares based upon full and complete information, the complaint alleging breach of fiduciary duty may not be dismissed in its entirety.
Because Count III alleges aiding and abetting a breach of fiduciary duty, and the direct claim for breach of fiduciary duty survives, in part, Count III may not be dismissed.
CONCLUSION
Defendant's motion to dismiss is allowed, in part, and denied, in part. Count II is dismissed. Count I is dismissed to the extent it seeks damages that, as described above, must be claimed in a derivative action on behalf of the corporation. Otherwise, the motion to dismiss is denied.