Jon Sugarman v. Leonard Sugarman and Statler Industries, Inc.
1986 U.S. App. LEXIS 26648, 797 F.2d 3 (1986)
Premium Feature
Subscribe to Lexplug to listen to the Case Podcast.
Rule of Law:
Shareholders in a close corporation owe one another a fiduciary duty of 'utmost good faith and loyalty,' which a majority shareholder breaches by engaging in a 'freeze-out' scheme designed to deprive minority shareholders of financial benefits. A direct claim for such a breach of fiduciary duty is characterized as a tort action for purposes of calculating pre-judgment interest, but attorney's fees are generally not recoverable by prevailing parties in such direct actions without specific statutory authority or a common fund benefit.
Facts:
- In 1906, four brothers formed a partnership, Sugarman Brothers, for selling paper products, which by 1918 was equally owned and managed by Joseph, Samuel, and Myer Sugarman.
- In the 1930s, the principals organized Leonard Tissue Corporation, also owned equally by the three Sugarman branches; after World War II, Sugarman Brothers was incorporated with equal ownership.
- In 1969, Leonard Tissue (renamed Statler Tissue) and Sugarman Brothers merged to create Statler Corporation, with common stock owned in approximately equal amounts by each of the three Sugarman branches.
- Leonard Sugarman's father, Myer, and appellees' father, Hyman, were both officers and directors of Statler.
- In 1974, Hyman Sugarman sold his shares in Statler to Leonard Sugarman, leading to Leonard and his immediate family owning 49.6% of outstanding stock, effectively giving Leonard control of the company.
- The redemption of Joseph Sugarman's stock at an unspecified later date resulted in Leonard owning over half of the outstanding shares, while Jon, James, and Marjorie Sugarman (Samuel's grandchildren) owned 21.78%.
- In 1980, Leonard Sugarman offered to buy Jon and Marjorie Sugarman's stock for $3.33/share, even though the company's accountants, Price Waterhouse, had determined the book value of the stock to be $16.30/share in that year.
- From 1978 to 1984, Leonard Sugarman received excessive compensation from Statler and also ensured his father, Myer, received substantial salaries and a $75,000 pension until age 88, while Hyman received no comparable pension benefits upon his departure from the company in 1980.
Procedural Posture:
- In 1981, Jon, James, and Marjorie Sugarman (plaintiff-appellees) brought suit against Leonard Sugarman (defendant-appellant) in the United States District Court for the District of Massachusetts.
- Count I of the complaint sought a derivative recovery against Leonard on behalf of Statler, alleging he caused Statler to pay him excessive salary and engaged in self-dealing.
- Count II sought direct recovery for appellees against Leonard, alleging a 'freeze-out' of minority shareholders through denial of employment, draining earnings via excessive compensation to Leonard, and refusal to pay dividends.
- The District Court found that Leonard breached his fiduciary duty by engaging in a freeze-out, specifically finding his overcompensation was in bad faith and part of a freeze-out attempt, and that he offered to buy stock at a grossly inadequate price.
- The District Court awarded damages directly to appellees, totaling $537,925, which included a percentage of improper payments to Leonard and Myer, attorney's fees, costs, and annual interest at 12% from the dates of payments under Mass.G.L. c. 231, § 6C.
- Leonard Sugarman appealed the District Court's judgment to the United States Court of Appeals for the First Circuit.
Premium Content
Subscribe to Lexplug to view the complete brief
You're viewing a preview with Rule of Law, Facts, and Procedural Posture
Issue:
Does a majority shareholder's conduct, including excessive self-compensation, differential treatment of family members, and an inadequate offer to buy minority shares, constitute a 'freeze-out' breaching their fiduciary duty to minority shareholders in a close corporation, thereby entitling the minority shareholders to direct damages and attorney's fees, and what is the proper Massachusetts statute for calculating pre-judgment interest on such a claim?
Opinions:
Majority - Coffin, Circuit Judge
Yes, a majority shareholder's conduct, including excessive self-compensation, differential treatment of family members, and an inadequate offer to buy minority shares, constitutes a 'freeze-out' breaching their fiduciary duty, entitling minority shareholders to direct damages, but they are not entitled to attorney's fees under the circumstances of this direct action, and pre-judgment interest should be calculated under the tort statute. The court affirmed the district court's finding of liability for freeze-out, citing Donahue v. Rodd Electrotype Co. and Wilkes v. Springside Nursing Home, Inc., which established that shareholders in a close corporation owe one another a fiduciary duty of 'utmost good faith and loyalty.' A freeze-out occurs when majority shareholders employ devices like refusing dividends, draining earnings through exorbitant salaries and bonuses, depriving minority shareholders of employment, and offering to buy shares at inadequate prices, all designed to ensure minority shareholders receive no financial benefits from the corporation and pressure them to sell. The district court correctly found that Leonard's overcompensation was 'effected in bad faith, as part of an attempt to freeze out minority interests,' and that his offer to buy the minority stock at a 'grossly inadequate price' was the 'capstone of a plan to freeze out appellees.' The court upheld the district court's findings on payments to Myer, the stock offer valuation, and Leonard's compensation, rejecting various alleged factual and legal errors, including arguments regarding IRS audits, sales commissions, bonus plans, and 'catch-up' pay. The court also affirmed the district court's application of laches. However, the court found error in the calculation of interest and the award of attorney's fees. Regarding interest, the court determined that a breach of fiduciary duty involving an intentional freeze-out is a tort, not a contract action. Therefore, Mass.G.L. c. 231, § 6B, governing tort actions, should apply, requiring interest from the date of commencement of the action, rather than Mass.G.L. c. 231, § 6C, which applies to contract actions and allows interest from the date of breach. For attorney's fees, the court reversed the award, explaining that the general rule in Massachusetts is that attorney's fees are not recoverable without specific statutory or contractual provision. The exception for derivative actions (the 'fund' exception), where a litigant creates a common fund for all shareholders, does not apply here because the appellees received direct damages for their personal freeze-out claim.
Analysis:
This case reinforces the stringent fiduciary duty owed by majority shareholders to minority shareholders in close corporations under Massachusetts law, originating from Donahue. It clarifies that a 'freeze-out' claim is a direct action where the minority shareholders seek personal redress, distinct from a derivative action benefiting the corporation as a whole. The ruling specifies that a breach of fiduciary duty leading to a freeze-out is considered a tort for interest calculation purposes, aligning it with other intentional wrongs. Importantly, it emphasizes that while such conduct is reprehensible, the 'American Rule' on attorney's fees generally prevails, limiting their recovery in direct actions unless a specific exception (like the 'fund' exception in derivative suits) or bad faith in litigation is proven. This distinction is crucial for future minority shareholder litigation, guiding both the characterization of claims and the scope of available remedies.
