McPhail v. L.S. Starrett Company

United States District Court for the District of Massachusetts · 1957 · Corporations

157 F. Supp. 560 (1957)

Updated August 22, 2026

CorporationsEmployee stock option plansShare issuanceShareholder votingemployee stock option planMassachusetts corporation lawconsiderationoptions as offers

Facts

L.S. Starrett Company, a Massachusetts corporation with one class of no-par common stock, adopted an employee stock option plan under which up to 20,000 authorized but unissued shares could be offered to eligible employees at fair market value on the date of a 30-day option. Employees who exercised an option could pay in installments over as long as ten years, would become owners with full voting and dividend rights upon signing the purchase agreement and making the first payment, and would pledge the shares to the company as security for the unpaid balance. The plan was approved by the board, approved by relevant securities regulators, and then approved by the shareholders by a majority vote. Plaintiff McPhail, a substantial shareholder, challenged the plan as lacking consideration, unlawfully using dividends to pay for stock, diluting existing shareholders, having been approved through misstatements, and serving to entrench management control.

Issue

Whether the company's employee stock option plan was illegal under Massachusetts law or improperly adopted because the options allegedly lacked consideration, dividends could be used toward payment, the plan would dilute existing shareholders and impose costs, proxy solicitation involved misrepresentations, and the plan was intended to perpetuate management control. Also, whether the shareholder vote validly authorized the issuance of stock under the plan.

Rule

In Massachusetts, an employee stock option that is in substance only a short-term offer to sell stock at market price, with no market value as a separate asset, need not be supported by independent consideration. A corporation may issue no-par stock payable in installments, and once shares are issued as outstanding shares of the only class, dividends must be paid equally on them and may be applied to the employee purchaser's unpaid balance as a security device. A majority vote of all stockholders may authorize an increase and issuance of shares without first offering them to existing stockholders.

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Bay Harbor Instruments, a Massachusetts corporation based in Worcester, adopts a plan allowing any employee with nine months of service to buy no-par common shares at the fair market price stated on the day of grant. Each option may be exercised only by the employee within 21 days, and the corporation receives no separate payment for granting the option itself.

A shareholder sues to block the plan, arguing the options are invalid because they are unsupported by separate consideration. How should a court most likely rule?

Explanation. The majority treated a short-term employee option priced at fair market value and lacking independent market value as merely an offer to sell stock, not a separately valuable contract right. Under that reasoning, no separate consideration is required for the option itself.