Sugarman v. Sugarman

United States Court of Appeals for the First Circuit · 1986 · Corporations

CorporationsClose corporationsMinority shareholder freeze-outFiduciary dutyclose corporationfreeze-outsqueeze-outfiduciary duty

Facts

Statler Corporation was a close corporation owned by branches of the Sugarman family, and after 1974 Leonard Sugarman effectively controlled the company and held a majority of the stock. The minority plaintiffs alleged that Leonard froze them out by draining earnings through excessive compensation to himself, favoring his father Myer with salary and pension benefits not given to plaintiffs' father Hyman, never paying dividends, and offering to buy Jon and Marjorie's shares at an inadequate price. The district court found Leonard's overcompensation from 1978 to 1984 was effected in bad faith as part of an attempt to freeze out minority interests, and also found the disparate payments to Myer and the low stock offer supported that conclusion. The district court awarded the minority shareholders direct damages equal to their ownership percentage of the improper payments, plus interest and attorney's fees.

Issue

Whether the evidence and findings supported a direct freeze-out claim against the majority shareholder of a close corporation, rather than only a derivative claim for excessive compensation. Also, what Massachusetts interest statute governed the award and whether attorney's fees were recoverable on the direct freeze-out recovery.

Rule

To establish a freeze-out in a close corporation, a minority shareholder must prove that the majority intentionally used corporate devices to cut the minority off from financial benefits of the corporation, such as dividends, employment, or fair participation in corporate earnings, and that a low-price stock purchase offer was part of that overall plan rather than a standalone event. Excessive compensation alone supports a derivative claim unless specifically alleged and proved as part of a bad-faith attempt to freeze out the minority. A direct freeze-out claim sounds in tort for purposes of Massachusetts prejudgment interest, so interest is governed by Mass. G.L. c. 231, § 6B, and attorney's fees are not recoverable absent a recognized exception, which does not apply where recovery is direct rather than creating a common fund for the corporation.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

North Harbor Components, Inc., a close corporation based in Worcester, Massachusetts, is controlled by Dana Pike, who owns 62% of the shares. Dana has paid herself unusually high salary for three years, but the minority shareholders still receive regular dividends, remain employed by the company, and have never been asked to sell their stock.

If the minority shareholders sue Dana directly for freeze-out based only on the excessive compensation, what is the strongest argument for Dana?

Explanation. A direct freeze-out claim requires proof that the majority intentionally used corporate devices to deny the minority financial benefits of the corporation. Excessive compensation by itself supports a derivative claim for the corporation, not a direct freeze-out claim, unless it is specifically alleged and proved as part of a bad-faith freeze-out plan. Here, with dividends continuing, no employment exclusion, and no low-price offer, Dana's best argument is that the suit is derivative rather than direct.