Starr v. Fordham
1995 Mass. LEXIS 151, 648 N.E.2d 1261, 420 Mass. 178 (1995)
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Rule of Law:
Partners who have discretionary authority over profit distribution engage in self-dealing and breach their fiduciary duty and the implied covenant of good faith and fair dealing when they allocate profits in a manner that personally benefits them at the expense of another partner. Once self-dealing is shown, the business judgment rule does not apply, and the burden shifts to the self-dealing partners to prove their actions were fair and reasonable.
Facts:
- In 1984, Attorney Fordham invited Ian M. Starr to leave his current law firm and join a new firm, Kilburn, Fordham & Starrett.
- Fordham assured Starr that business origination (rainmaking) would not be a significant factor in allocating profits among partners.
- Relying on this, Starr joined the new firm and signed a partnership agreement on March 5, 1985, which vested the founding partners with the authority to determine each partner's share of the firm's profits.
- In September 1985, the partners, including Starr, committed to a new ten-year office lease, doubling their rent.
- For the year 1986, the firm's profits were over $1.6 million.
- Upon Starr's withdrawal on December 31, 1986, the founding partners determined his share of the 1986 profits to be 6.3%, based primarily on business origination, despite his billable hours and dollars constituting roughly 15-16% of the firm's total.
- The founding partners also refused to give Starr any share of the firm's accounts receivable and work in process, claiming that the firm's liabilities, including the full amount of the ten-year office lease, exceeded these assets.
Procedural Posture:
- Ian M. Starr sued his former partners in Superior Court for amounts due under the partnership agreement, breach of fiduciary duty, and fraudulent misrepresentation.
- The defendants counterclaimed, alleging Starr violated his fiduciary duties and breached the partnership agreement.
- After a jury-waived trial, the Superior Court judge found that the founding partners had violated their fiduciary duties and the implied covenant of good faith and fair dealing regarding the 1986 profit distribution, awarding Starr damages.
- The trial judge also found that Fordham had committed fraudulent misrepresentation.
- The trial judge rejected Starr's claim for a share of the firm’s accounts receivable and work in process and entered judgment for Starr on the defendants' counterclaims.
- Starr (appellant) appealed the ruling on accounts receivable and the calculation of prejudgment interest.
- The founding partners (appellees) cross-appealed the findings of fiduciary breach and fraudulent misrepresentation.
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Issue:
Do partners with discretionary authority over profit distribution breach their fiduciary duty and the implied covenant of good faith and fair dealing when they engage in self-dealing by allocating a disproportionately small share of profits to another partner based on criteria selected to justify the lowest possible payment?
Opinions:
Majority - Nolan, J.
Yes. An unfair determination of a partner's share of a partnership's earnings is a breach of both fiduciary duty and the implied covenant of good faith and fair dealing. The founding partners engaged in self-dealing because their determination of Starr's profit share had a direct impact on their own shares. This act of self-dealing removes the protection of the business judgment rule and shifts the burden to the founding partners to prove their actions were fair, a burden they failed to meet. The court found that the founding partners selected performance criteria, such as business origination, in a manner designed to justify the lowest possible payment to Starr, which was unfair and a breach of their duties. However, the court also found that including the long-term office lease as a 'liability' under the partnership agreement when calculating Starr's share of accounts receivable was a permissible contract interpretation and not a breach of duty.
Analysis:
This case reinforces the high standard of fiduciary duty partners owe one another, extending the principle of good faith and fair dealing to discretionary compensation decisions within a partnership. It establishes that even where a partnership agreement grants certain partners sole discretion, that discretion is not absolute and is limited by fiduciary obligations. The decision clarifies that when partners making such decisions stand to personally benefit (self-dealing), their actions will be subject to strict judicial scrutiny for fairness, and the deferential business judgment rule will not apply. This holding serves as a significant check on the power of managing partners and protects minority partners from opportunistic or oppressive conduct.
