Directors of a Massachusetts corporation are fiduciaries. As fiduciaries, directors must insure that they do not sacrifice the corporation’s goal of enhancing profit and shareholder gain for their own interest or pecuniary gain. 

They owe a duty of reasonable care and a paramount duty of loyalty to the company.  Demoulas v. Demoulas Super Markets, Inc., 424 Mass. 501, 528-29 (1997).  In the exercise of their fiduciary responsibilities the directors are charged with acting in good faith and must exercise reasonable intelligence in conducting the affairs of the corporation.  Sagalyn v. Meekins, Packard & Wheat, Inc., 290 Mass. 434, 438 (1935).  Directors “are bound to act with absolute fidelity and must place their duties to the corporation above every other financial or business obligation . . .. They cannot be permitted to serve two masters whose interests are antagonistic.”  Demoulas, 424 Mass. at 528.  Directors must subordinate their personal pecuniary interests to their paramount duty to the corporation.  It is improper for directors and officers to promote their own interests in a manner harmful to the corporation.  Geller v. Allied-Lyons PLC, 42 Mass. App. Ct. 120, 122 (1997).

Likewise controlling stockholders in a close corporation owe other stockholders a fiduciary duty of utmost good faith and loyalty that partners owe one another. Donahue v. Rodd Electrotype Co. of New England, 367 Mass. 578 (1975). A close corporation is generally defined as having a small number of shareholders, no ready market for its stock, and substantial majority shareholder participation in the management, direction and operations of the corporation. Harrison v. NetCentric Corp., 433 Mass. 465, 469 n.6 (2001).

Majority shareholders in a close corporation cannot use oppressive devices, including withholding of dividends, to “freeze out” the minority interests.  Donohue, 367 Mass. at 588-89.

One example of improper conduct by a director or a controlling shareholder in a close corporation is when he or she improperly takes advantage of a business opportunity. This is the so-called corporate opportunity doctrine. It is fundamentally unfair for a director or senior executive of a company to take advantage of a business opportunity for his own profit when under the circumstances he or she should first present the opportunity to the company. This is particularly so when the director or executive becomes aware of a potential opportunity either in performing the function of director or executive or through the use of corporate information or property. Demoulas, 424 Mass. at 528-530.  If the company rejects the opportunity, after full disclosure of all material facts, the director or executive may pursue the opportunity for her own account. The decision to reject the opportunity must be made by disinterested directors or, if need be, by disinterested shareholders.  If the decision makers are not disinterested, then in any subsequent litigation, “the burden is on those who [have] benefit[ed] from the [new] venture to prove that the decision was fair to the corporation.” Demoulas, 424 Mass. at 531. These same principles apply equally to any “self dealing” transaction between the director or executive, on the one hand, and the corporation. 

Demand Requirements

When a corporate opportunity is wrongfully diverted or when in a self-dealing transaction the corporation pays too much for property or services, any harm to shareholders is derived indirectly from their ownership of the injured party, the corporation.

So the minority shareholder cannot sue in his own right but may be able to bring a claim on behalf of the corporation. This holds true whether there are three or three million shareholders.  This is called a derivative shareholder action. Only a person who is a shareholder at the time of the alleged wrongdoing, or whose shares for example were inherited from a person, who was a stockholder as the time of the alleged wrongdoing, has standing to sue.

Effective as of 2004, the Massachusetts Business Corporation statute underwent a comprehensive revision including adoption of detailed conditions for bringing a derivative shareholder suit.  Massachusetts General Laws Chapter 156D §§ 7.40-7.47. The universal requirement is that the complaining shareholder of a Massachusetts corporation must make demand on the corporation to bring the claim in its own right.

It “is … a basic principle of corporate governance, [that] the board of directors or majority of shareholders should set the corporation's business policy, including the decision whether to pursue a lawsuit.” Halebian v. Berv, 457 Mass. 620, 626(2010). So these decision makers must be given an opportunity to make a good faith determination of whether such a lawsuit is in the best interest of the corporation.

While the statutory procedure is detailed, a good faith, fully informed decision by a majority of independent directors or a disinterested majority of the shareholders that maintaining the derivative proceeding is not in the best interests of the corporation, bars the suit. G.L. c.156D §7.44.

This pre-suit condition is required even when the alleged wrongdoers control decisions of both the board and the stockholders.  Where there can be no informed decision by disinterested decision makers, a rejected demand is no bar to maintaining the derivative proceeding.

The statute specifies that the substantive demand requirements for a foreign corporation are to be determined by the state of incorporation. G.L. c.156D §7.47.

For Delaware corporations the substantive demand rule is different. In order to bring a derivative proceeding a shareholder of a Delaware corporation must either (1) make a pre-suit demand by presenting the allegations to the corporation's directors, requesting that they bring suit, and showing that they wrongfully refused to do so, or (2) plead facts showing that demand upon the board would have been futile. Stone v. Ritter, 911 A.2d 362, 366–67 (Del.2006).

And, whether brought for the benefit of a Delaware or a Massachusetts corporation, there are specific procedural rules concerning the prosecution of derivative actions that apply under both the Massachusetts Rules of Civil Procedure and the Federal Rules of Civil Procedure.

Statute of Limitations Considerations

When a director or executive takes a business opportunity rightfully belonging to the corporation the legal wrong is in the nature of a tort action for conversion and subject to a three-year statute of limitations. Demoulas, 424 Mass. at 517.  When a director or executive improperly takes excessive compensation, the wrong to the corporation is for money had and received, a legal wrong sounding in contract and subject to a six year period of limitations. Von Arnim v. American Tube Works, 188 Mass. 515, 517-520 (1905).

Where the injured party is the corporation and the wrongdoers control all decisions, the corporation cannot protect its interests and bring suit within the applicable period of limitations.  In addition, the minority stockholders may not learn of the wrongdoing until the passage of many years.

It is fundamentally unfair for a wrongdoer to evade liability when he covers up his wrongdoing whether by active concealment or by standing mute and silent in the face of a fiduciary duty to fall on his sword and disclose his wrongdoing. Under certain circumstances the law will prevent injustice from a rigid time bar calculated from three or six years from the date of the wrongdoing. This is particularly appropriate where the wrongdoer controls the injured party.

In the Demoulas case, the plaintiffs filed suit in April 1990 and successfully attacked self-dealing transactions in 1975, 1979, 1981 and at diverse other times. Where a defendant conceals the operative facts of the legal wrong, the doctrine of fraudulent concealment tolls or delays the statute of limitations from running. Demoulas, 424 Mass. at 517-18.  In addition a director’s silence and failure as a fiduciary to disclose those operative facts can constitute fraudulent concealment. That a derivative plaintiff might have discovered the wrongdoing if he had been more diligent does not bar the case on statute of limitations grounds. Puritan Medical Center v. Cashman, 413 Mass. 167, 172 (1992).

In a derivative shareholder action case following an eight-day trial in 2005, we successfully secured a verdict of annual excessive compensation paid from 1994 through 2005.  With prejudgment interest calculated from the dates of the wrongful payments, judgment entered at almost twice the verdict.

In a derivative suit a successful plaintiff is generally entitled to recover attorney’s fees.