Wilkes v. Springside Nursing Home, Inc.

Supreme Judicial Court of Massachusetts · 1976 · Corporations

CorporationsClose corporationsFiduciary dutiesMinority shareholder freeze-outclose corporationfiduciary dutyutmost good faith and loyaltyfreeze-out

Facts

Springside was a close corporation formed by Wilkes, Quinn, Riche, and Pipkin to operate a nursing home, with the shared understanding that each would be a director, each would participate actively in management, and each would receive equal payments from the corporation so long as each carried part of the business burdens. After Pipkin sold his shares to Connor, the remaining participants continued that arrangement, and the corporation never declared dividends. In 1967, after relations between Wilkes and Quinn deteriorated, the directors set salaries for Quinn, Riche, and Connor but omitted Wilkes, and at the annual meeting Wilkes was not reelected as director or officer and was told his services were not wanted. The master found these meetings were used to force Wilkes out of management and cut off all corporate payments to him, not because of misconduct or neglect, even though Wilkes had performed competently and was willing to continue working.

Issue

Did the majority shareholders in this close corporation breach their fiduciary duty to Wilkes, a minority shareholder, by removing him from salary, office, and directorship and thereby freezing him out of the enterprise? If so, could the majority justify its conduct by showing a legitimate business purpose?

Rule

Stockholders in a close corporation owe one another substantially the same fiduciary duty as partners owe one another: the duty of utmost good faith and loyalty. When minority shareholders claim that majority action breached that duty, the court must ask whether the controlling group can demonstrate a legitimate business purpose for its action; if it can, the minority may still show that the same legitimate objective could have been achieved through an alternative course of action less harmful to the minority's interests, and the court must weigh the asserted purpose against the practicability of the less harmful alternative.

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

Three siblings and a family friend form Lakeshore Therapy Center, Inc., a small Chicago close corporation. Each buys the same number of shares, each serves as a director, and for years the company distributes profits only through equal salaries tied to active work rather than dividends.

If the controlling shareholders later cut the friend off the payroll and remove her from the board for personal reasons unrelated to performance, what standard will a court most likely apply to their conduct?

Explanation. In a close corporation, shareholders owe one another substantially the same fiduciary duty as partners: utmost good faith and loyalty. The majority opinion treats close-corporation relationships differently because majority owners can freeze out minority owners through control over salary, office, and participation. Formal board action does not eliminate that fiduciary review. (Derived from Wilkes v. Springside Nursing Home, Inc. (1976).)