Unauthorized Acts by Shareholder Leads to Judgment in Close Corporation Dispute

A recent Massachusetts Appeals Court decision about a close corporation dispute illustrates the challenges that can arise when there is a conflict among a small group of investors.

Being part of a company with a small number of investors or a family-owned business can be a great experience. These companies – known as “close corporations” – are typically run by a tight-knit group of family members or individuals.

When things are going smoothly, and the company’s owners are making a return on their investment, there’s no cause for complaint. As with any business venture, however, internal conflicts can arise. Shareholder disputes in close corporations can take many forms. For example, it is not uncommon for a shareholder or group of shareholders to want a co-owner to leave the company. Differences in management styles or personality conflicts can drive a wedge between business partners. Tensions can also develop between majority and minority ownership interests.

Discord Among Shareholders Leads to IT Lockdown

On July 7, 2020, the Massachusetts Appeals Court issued a decision titled Bernstein v. MyJoVE Corp. describing the deterioration of a relationship among co-founders of a close corporation. The dispute involves MyJoVE, an internet-based publisher of scientific journals, and one of its shareholders. According to the Appeals Court decision, MyJoVE’s former chief technology officer – who was also a thirty percent shareholder – left the company, and later used his knowledge of MyJoVE’s computer systems to gain control of MyJoVE’s website, and to cut off the email access of MyJoVE’s chief executive officer for several days.

MyJoVE was started in 2006, and its co-founders included Nikita Bernstein and Moshe Pritsker. Each co-founder owned thirty percent of the company. Mr. Pritsker is the company’s president and CEO, and Mr. Bernstein was the CTO.

In 2011, Mr. Bernstein stepped down as the company’s CTO, but continued to provide some consulting. In late 2011, according to the Appeals Court decision, Mr. Bernstein “became increasingly critical of what he perceived as various missteps by MyJoVE’s IT department, as well as, more generally, of Pritsker’s management. Bernstein and Pritsker had several disagreements about the extent to which Bernstein would be permitted to interact with other employees, and to have access to the company’s offices. Bernstein also became frustrated that Pritsker was not communicating with him as he wished.”

In November 2012, Mr. Bernstein transferred the company’s website to his personal account, gained access to the company’s emails, and changed the password on Mr. Pritsker’s email account – thereby blocking the company’s CEO from accessing his own emails.

The parties filed claims against each other in a Massachusetts Superior Court, and the company obtained a preliminary injunction compelling Mr. Bernstein to relinquish the company’s domain name, and to return control of the company’s computer system to the company.

The Appeals Court ruled that Mr. Bernstein’s “status as a shareholder of a close corporation did not give him a right to engage in unauthorized acts.” Adding that “[a]llowing a party who has [allegedly] suffered harm within a close corporation to seek retribution by disregarding its own duties has no basis in our laws and would undermine fundamental and long-standing fiduciary principles that are essential to corporate governance.” The Appeals Court explained that if shareholders are “unable to resolve matters amicably, aggrieved parties should take their claims to court and seek judicial resolution.” The Appeals Court upheld the trial court’s $60,313 judgment in favor of the company.

Resolving Shareholder Conflict With Help From Advisors

As this case shows, the very thing that can make a close corporation successful – a small group of investors who decide among themselves how to operate the venture – can also make resolution of internal disputes difficult. Because when the small group of owners disagree about how to run the company or who should be in charge, the path to a resolution is not always clear. When tempers flare, shareholder agreements and by-laws are not always helpful for resolving management deadlock.

It can be tricky to find the right solution for parties who are involved in a close corporation dispute. Sometimes, a collaborative process can yield positive results. Other times, it is necessary to resort to litigation. The type of solution is heavily dependent on the nature of the dispute and the dynamics of the owners.

In most cases, obtaining the advice of an attorney who has experience untangling the thicket of ownership interests and legal obligations is the critical first step toward reaching a resolution. Beck Reed Riden LLP’s attorneys frequently handle these types of disputes – both in and out of court. If you have any questions or if you are involved in a close corporation dispute, please contact us to discuss your situation. Attorneys Russell Beck and Stephen Riden have years of experience in this area and they can be reached via email (info@beckreed.com) or telephone (617-500-8660).

Beck Reed Riden LLP is Boston’s innovative litigation boutique. Our lawyers have years of experience working with clients ranging from Fortune 500 companies to start-ups and individuals. We focus on business litigation and employment. We are experienced litigators and counselors, helping our clients as business partners to resolve issues and develop strategies that best meet our clients’ legal and business needs – before, during, and after litigation. We’re ready to roll up our sleeves and help you. Read more about us, the types of matters we handle, and what we can do for you here.

Working Out Corporate Conflict

HiResStarting a new business with an old friend is the path to the American Dream for many entrepreneurs. Two famous friends who did just that were Bill Hewlett and Dave Packard, they met in college and worked together to start Hewlett-Packard, one of the most successful technology companies in the world. Legions of startups have followed Hewlett and Packard’s example, with friends getting together to launch countless businesses. Whether it’s launching a food truck or a software app, founders of small businesses face myriad challenges. Sometimes the hardest challenge for co-owners is figuring out how to get along with one another.

Screen Shot 2014-10-15 at 2.30.37 PMrecent Massachusetts Superior Court decision details the rocky road traveled by one group of friends who started a business together. The story begins in 1999, when a group of founders, including two high school friends and roommates named Tony Beninati and Steven Borghi, decided to open a gym. Tony and Steven each brought in one additional investor for their business venture.

The four co-owners eventually opened a string of health clubs in New England under the licensed name Work Out World (“WOW”). The group formed fourteen separate limited liability companies to own each club and a fifteenth to centralize management and administration for all of the clubs.

Unfortunately, significant conflicts arose among the co-owners of WOW New England, leading to a lawsuit in Suffolk County Superior Court named Beninati v. Borghi, and eventually resulting in a multi-million dollar verdict against one of the original founders.

To understand how a court views conflicts among owners in a small business, it is first helpful to understand some basics of Massachusetts law concerning close corporation disputes.

What Is A Close Corporation?

A close corporation is a corporation for which no ready market exists for the trading of its shares. Thus, the shares are neither publicly traded on a stock exchange nor can they be sold to members of the public. The shares of a close corporation are held by a small number of shareholders or investors, who are usually heavily involved in the management and day-to-day operations of the business.

Typically a close corporation is a family business or one that is owned by a small group of investors. It can range from a mom-and-pop restaurant to an IT consulting company.

In the Beninati v. Borghi case, since the business was formed as a set of limited liability companies, the court treated the companies as closely-held business entities.

Shareholders’ Duties In A Close Corporation

As a general matter, stockholders of a close corporation owe each other a duty of utmost good faith and loyalty. They cannot act in self-interest where it will harm the company.

A controlling shareholder cannot pursue any course of conduct if there are alternatives that would be less harmful to minority shareholders. Massachusetts law protects minority shareholders because they cannot sell their stock to avoid oppressive behavior by controlling shareholders.

When Conflict Leads To A Lawsuit

Where a shareholder, director, or officer of a close corporation has violated duties to the corporation itself, any shareholder or director may bring a derivative suit on behalf the corporation. And where the wrongful actions have harmed a shareholder’s interests, the shareholder may bring a direct suit to seek personal relief.

What Went Wrong With WOW New England?

The group’s dynamic changed when Tony passed away and his wife, Elizabeth, took his place. Disagreements arose, most importantly over the issue of expansion. Steven was looking to add more clubs whereas Elizabeth and another owner had misgivings about Steven’s proposals.

Taking matters into his own hands, Steven joined forces with Harold Dixon, an experienced franchisor, to pursue his expansion dreams. Together, Steven and Harold formed Blast Fitness and opened their own string of competing WOW health clubs in New England.

The remaining members of the WOW New England group were not pleased to learn that one of their co-owners was setting up new gyms in competition with WOW New England, so they brought a lawsuit against Steven and Harold in the Superior Court of Massachusetts.

Because Steven took matters into his own hands and started competing health clubs, the court ruled that he violated his fiduciary duties to WOW New England in the following ways.

  • He misappropriated confidential information and used it in direct competition with WOW New England. The information included membership data, revenue information, membership demographic reports, employee training manuals, payroll data, and a list of the clubs’ vendors.

  • He used WOW New England’s assets to open and operate the competing clubs, including having WOW New England employees work for Blast while on WOW New England’s payroll.

  • He violated his noncompete agreement with WOW New England forbidding him from opening a competing venture.

In 2014, the court found Steven liable and awarded damages to his co-owners, including $1.5 million for use of WOW New England’s advertising and $2.5 million in royalty payments.

Whether or not an act breaches one’s fiduciary duty often depends on the specific facts of each case, and it is therefore advisable to seek legal advice early on in the decision-making process.

Beck Reed Riden LLP Excels In Close Corporation Dispute Resolution

With years of experience representing partners, owners, and family members in a variety of corporate disputes, Russell Beck and Stephen Riden provide thoughtful guidance to business owners involved in shareholder disputes. Beck Reed Riden LLP is committed to developing custom-fit, appropriate solutions for the complex relationships that are inherent in these types of conflicts. Beck Reed Riden LLP can be reached now for a free consultation via email (info@beckreed.com) or telephone (617-500-8660).

Stuck in the Middle of a Close Corporation Dispute

Screen Shot 2014-10-15 at 1.25.29 PMyou happened to pick up a comic book from the 1950s, you may have come across an advertisement for the Junior Sales Club of America.

Screen Shot 2014-01-07 at 11.27.27 AM

The Junior Sales Club of America (JSCA) was a family-owned greeting card company that promoted its products by incentivizing kids to sell boxed assortments of cards in exchange for money and prizes. A young entrepreneur who sold enough cards could win exciting prizes, like a compass, a camp stove, oreven an air rifle. With a business model that embodied the American dream, JSCA became a symbol of bygone era. However, behind the scenes of Junior Sales Club of America’s cheerful ads, there was conflict, division, and a bitter legal battle. The story of this closely held, family business unfolds in a 1982 Massachusetts Appeals Court case named O’Hara v. Robbins.

In The Company Of Family And Friends 

In 1953, the Robbins family started Sunshine Art Studios, Inc., a company that manufactured and sold greeting cards. Willard S. Robbins held 50% of the shares. His wife, Grace B. Robbins, held 10% and their son, Ryland E. Robbins, held the remaining 40%. Ryland’s college classmate and friend, Arthur P. O’Hara, worked for Sunshine in charge of promotions and sales. In 1954, Arthur proposed a novel business model by which the company would give prize and money incentives to young people to sell Sunshine greeting cards. The model was implemented under the name of Junior Sales Club of America. After JSCA was Screen Shot 2014-01-07 at 10.49.58 AMincorporated, Arthur was given a certificate for 20% of the shares, and Ryland and Willard each kept 40% ownership of the company. Although he never invested in JSCA, or negotiated for the shares, Arthur’s salary reflected 20% of JSCA’s profits.

A Shareholder Left Out In The Cold

Two years after proposing the novel sales incentive program, Arthur proposed another program that would operate essentially the same as JSCA but offer better incentives for sellers and sponsors. Arthur’s new business idea became a reality when he and his business partners started a new company: Sales Leadership Club, Inc. (Sales Leadership). Unfortunately for Arthur, however, a partnership tax return filed in 1958 named only Willard, the father, and Ryland, the son, as Screen Shot 2014-01-07 at 2.37.05 PMpartners. Then, in 1959, Arthur was told that he did not own interest in Sales Leadership. Nevertheless, Arthur was paid a percentage of the profits for the next three years. Further, money from JSCA was used in part to fund the expenses of Sales Leadership. Arthur continued to work for Sunshine until 1965, when he resigned from the Robbins companies over an unrelated dispute. Arthur asked for shares in Sales Leadership after he resigned from the company, but the Robbins family refused.

Screen Shot 2014-01-07 at 10.46.45 AMArthur sued his business partners seeking injunctive relief and damages. The trial judge found that the Sales Leadership model was a “corporate opportunity” that should have been reserved for JSCA. By diverting business to a competing operation (i.e., Sales Leadership), the Robbins failed to honor their fiduciary obligations to JSCA and to Arthur as a minority shareholder. The trial court ruled in Arthur’s favor and ordered the Robbins to transfer 20% of the shares of Sales Leadership directly to Arthur. The trial court’s decision was upheld on appeal.

Shareholders’ Duties In A Close Corporation

Shareholder disputes in close corporations can take many forms. And the type of dispute that landed the co-owners of the Junior Sales Club of America in a courtroom is quite common. Tensions often develop between majority and minority ownership interests. The specific conflict in this case that drove a wedge between business partners was the father and son’s breach of the corporate opportunity doctrine. The corporate opportunity doctrine stands for the legal principle that directors, officers, and majority shareholders may not usurp a beneficial business opportunity without first presenting it to the corporation.

Screen Shot 2014-01-07 at 10.55.06 AMTo determine whether a corporate opportunity exists, the courts will often ask (1) whether the opportunity was within the company’s line of business; (2) whether the company was financially able to take advantage of the opportunity at the time of appropriation; (3) whether the company had an interest or expectancy in the opportunity; and (4) whether taking a the opportunity would create a conflict of interest or breach of other fiduciary duties.

The corporate opportunity doctrine stems from the fiduciary duty of loyalty, which generally prohibits directors, officers, and shareholders from stealing assets, self-dealing, engaging in insider trading, and otherwise advancing personal interests to the detriment of the corporation. Owners, officers, and directors also have the duty of care, the obligation to exercise reasonable care when making decisions on behalf of the corporation. Although some instances of misconduct (e.g., embezzlement) are obvious, other situations are not as clear. This may be the case, for example, when the opportunity involves business that is related but not identical to the business of the corporation.

When Conflict Leads To A Lawsuit

Where a shareholder, director, or officer of a close corporation has violated duties to the corporation itself, any shareholder or director may bring a derivative suit on behalf the corporation. And where the wrongful actions have harmed a shareholder’s interests, the shareholder may bring a direct suit to seek personal relief. Here, Arthur was able to sue his business partners directly because his personal interests as minority shareholder of JSCA were harmed when the Robbins—who were both directors, officers, and majority shareholders of JSCA—diverted business to a competing enterprise: Sales Leadership. Whether or not an act breaches one’s fiduciary duty often depends on the specific facts of each case, and it is therefore advisable to seek legal advice early on in the decision-making process.

Beck Reed Riden LLP Excels In Close Corporation Dispute Resolution

With years of experience representing partners, owners, and family members in a variety of corporate disputes, Russell Beck, Stephen Riden, and their commercial litigation colleagues provide thoughtful guidance to business owners involved in shareholder disputes.

Beck Reed Riden LLP is committed to developing custom-fit, appropriate solutions for the complex relationships that are inherent in these types of conflicts. Beck Reed Riden LLP can be reached now for a free consultation via email (info@beckreed.com) or telephone (617-500-8660).

Beck Reed Riden LLP is Boston’s innovative litigation boutique. Our lawyers have years of experience working with clients ranging from Fortune 500 companies to start-ups and individuals. We focus on business litigation and employment. We are experienced litigators and counselors, helping our clients as business partners to resolve issues and develop strategies that best meet our clients’ legal and business needs – before, during, and after litigation. We’re ready to roll up our sleeves and help you. Read more about us, the types of matters we handle, and what we can do for you here.

Navigating the Pitfalls of Close Corporations and Shareholder Disputes

Being part of a family-owned business or a company with a small number of investors can be a great experience – these types of companies embody the spirit of entrepreneurship and form the bedrock of our economy.

These companies – known as “close corporations” – are typically run by a tight-knit group of family members or individuals. Some close corporations are multi-generational family businesses, others are new enterprises, often started with little more than a great idea, an opportunity in the marketplace, and some capital.

When things are going smoothly, and the company’s owners are making a return on their investment, there’s no cause for complaint. As with any business venture, however, internal conflicts can arise. Shareholder disputes in close corporations can take many forms. For example, it is not uncommon for a shareholder or group of shareholders to want a co-owner to leave the company. Differences in management styles or personality conflicts can drive a wedge between business partners. Tensions can also develop between majority and minority ownership interests.

The very thing that can make a close corporation successful – a small group of investors who decide among themselves how to operate the venture – can also make resolution of internal disputes difficult. Because when the small group of owners disagree about how to run the company or who should be in charge, the path to a resolution is not always clear. When tempers flare, shareholder agreements and by-laws are not always helpful for resolving management deadlock.

It can be tricky to find the right solution for parties who are involved in a close corporation dispute. Sometimes, a collaborative process can yield positive results. Other times, it is necessary to resort to litigation. The type of solution is heavily dependent on the nature of the dispute and the dynamics of the owners.

In most cases, obtaining the advice of an attorney who has experience untangling the thicket of ownership interests and legal obligations is the critical first step toward reaching a resolution. Beck Reed Riden LLP’s attorneys frequently handle these types of disputes – both in and out of court. The guide below provides some further background about the nature of close corporation disputes. If you have any questions or if you are involved in a close corporation dispute, please contact us to discuss your situation. Attorneys Russell Beck and Stephen Riden have years of experience in this area and they can be reached via email (info@beckreed.com) or telephone (617-500-8660).

What is a close corporation?

A close corporation is a corporation for which no ready market exists for the trading of its shares. Thus, the shares are neither publicly traded on a stock exchange nor can they be sold to members of the public. The shares of a close corporation are held by a small number of shareholders or investors, who are usually heavily involved in the management and day-to-day operations of the business.

Typically a close corporation is a family business or one that is owned by a small group of investors. It can range from a mom-and-pop restaurant to an IT consulting company.

Shareholders’ duties in a close corporation

Stockholders of a close corporation owe each other a duty of utmost good faith and loyalty. A controlling shareholder cannot pursue any course of conduct if there are alternatives that would be less harmful to minority shareholders. Massachusetts law protects minority shareholders because they cannot sell their stock to avoid oppressive behavior by controlling shareholders.

When disputes might arise between owners of a small business

Disagreement can lead to disastrous results if the shareholders are caught unprepared. For example, a shareholder might decide she no longer wants to remain involved in the business and start a competing venture, taking clients with her. Siblings in a family business might become embroiled in a family feud and cannot reach an amicable resolution because one sibling has taken the assets. Or a couple that owns a restaurant might decide to go their separate ways.

A court’s resolution of disputes between small business owners

Resorting to the courts does not necessarily lead to optimal results. In some cases, the only recourse in a close corporation dispute is the dissolution of the corporate entity, a solution that many shareholders find unsatisfactory.

The case of Graham v. Fish, a Massachusetts Superior Court case decided on May 4, 2011, illustrates how one court’s resolution of such business disputes can lead to harsh results. In that case, Gordon Graham and David Fish were the sole shareholders of Tennis Camps at Harvard, Inc., a children’s summer camp. Both Graham and Fish held contract positions as Harvard tennis coaches, which allowed them to access Harvard’s facilities during the summer. When Graham lost his contract position, Fish became uninterested in continuing the business relationship and formed a competing camp, the Tennis Academy.

Graham sued Fish for breach of fiduciary duty. Although shareholders of a close corporation owe each other the duty of utmost good faith and loyalty, the court ruled that it would impose no liability on Fish unless Graham could show that there was a less harmful and reasonably practicable alternative to achieve the legitimate business purpose. Thus, the court found that Fish was free to seek dissolution and establish a new camp, because he was under no obligation to continue the business. According to the court, when Graham lost his access to the Harvard facilities, Fish had a legitimate business purpose for discontinuing the camp he owned with Graham.

The Graham case illustrates that an aggrieved shareholder may not be able to recover in court unless he can affirmatively show one of two things: either that the alleged wrongdoer has no legitimate business purpose for his action, or that there was a legitimate business purpose but that objective could have been achieved through a less harmful alternative means. In practice, these can be difficult standards to meet.

In essence, to prevail in a dispute over a party’s alleged breach of fiduciary duties, courts want to see evidence that one of the parties acted in a clandestine manner, stole corporate assets for his exclusive use, or misused corporate assets in launching a competing entity. In the court’s view, the only remaining solution is to dissolve the corporation. For most shareholders, dissolution of the corporation is not a satisfactory answer.

Beck Reed Riden LLP Excels In Close Corporation Dispute Resolution

With years of experience representing partners, owners, and family members in a variety of corporate disputesRussell BeckStephen Riden, and their commercial litigation colleagues provide thoughtful guidance to business owners involved in shareholder disputes.

Beck Reed Riden LLP is committed to developing custom-fit, appropriate solutions for the complex relationships that are inherent in these types of conflicts. Beck Reed Riden LLP can be reached now for a free consultation via email (info@beckreed.com) or telephone (617-500-8660).

Beck Reed Riden LLP is Boston’s innovative litigation boutique. Our lawyers have years of experience working with clients ranging from Fortune 500 companies to start-ups and individuals. We focus on business litigation and employment. We are experienced litigators and counselors, helping our clients as business partners to resolve issues and develop strategies that best meet our clients’ legal and business needs – before, during, and after litigation. We’re ready to roll up our sleeves and help you. Read more about us, the types of matters we handle, and what we can do for you here.