One of the first considerations to make when starting a business is whether to create a formal corporate entity. The creation of a formal entity and compliance with state prescribed formalities can offer business owners and members substantial protections from individual liability for business debts when acting by and through an entity. One particularly popular corporate form is the Limited Liability Company (LLC). LLCs are governed by state law and, if established and maintained properly, LLCs can offer a flexible and relatively uncomplicated business form.
While LLCs protect members from individual liability related to the claims of outside actors as against the LLC, members do owe certain duties in exchange for such protection. In Massachusetts, as in other jurisdictions, members of corporate entities owe implicit duties of loyalty and care to the entity. Unlike other jurisdictions, however, in Massachusetts heightened protection is given to shareholders in what are referred to as “close” corporations, or corporations where, there exists “(1) a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation.” Donahue v. Rodd Electrotype Co. of New Eng., Inc., 328 N.E.2d 505, 511 (Mass. 1975). Massachusetts views such entities as little more than incorporated partnerships, and thus, insists that shareholders in close corporations, “owe one another substantially the same fiduciary duty [loyalty and care] in the operation of the enterprise that partners owe to one another.” Brodie v. Jordan, 857 N.E.2d 1076, 1080 (Mass. 2006).
Majority shareholders have been found to have violated their fiduciary duties toward minority shareholders in instances where, the “majority frustrates the minority’s reasonable expectations of benefit from their ownership of shares.” Id. Massachusetts refers to this tactic by a majority as a “freeze out,” as it creates a dynamic where a disadvantaged minority party can be compelled to come to inequitable terms with the majority party in order to leave the entity. Thus, Massachussets provides additional protections to close corporations in an attempt to dissuade “freeze outs.”
While this heightened duty is explicitly applied to shareholders of close corporations, it is very likely that courts in Massachussets could apply the same to members of LLCs, where the definition of “close” corporation is easily applicable by analogy. Thus, members of LLCs need to be aware that they not only owe duties of loyalty and care to the entity itself, but may also owe the same to their contemporaries as well. If you have questions with regard to business formation and/or operations you should consult with a knowledgeable attorney to determine your best options.