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What Duties Does a Minority Shareholder/Employee Owe Following a Wrongful "Freeze Out"?

As discussed in a previous blog post, a well-drafted shareholder or employee agreement is extremely important to clarify the rights and duties of an employee who is also a minority shareholder of a Massachusetts close corporation.  The need for a clear agreement is especially important if there is a dispute concerning the termination of a minority shareholder/employee.  Where no agreement exists, or if the applicable agreement does not entirely govern the rights and duties of the parties in a particular situation, the obligations are governed by their fiduciary duties to each other, which may be unclear depending on the circumstances.

Cases addressing whether the majority breached a fiduciary duty by terminating a minority shareholder/employee are not entirely consistent.  In Wilkes v. Springside Nursing Home, the Supreme Judicial Court ("SJC") articulated a two-part test for determining if a majority shareholder has violated his fiduciary duty to the minority.  First, the majority must show that there was a legitimate business purpose for the action that allegedly is a breach.  If such a showing is made, the burden then shifts to the minority to show that the purpose could have been accomplished through a less harmful, reasonably practicable alternative.  When the alleged "freeze out" is the termination of employment, however, the two-part test articulated in Wilkes may not be the only analytical framework.  In Merola v. Exergen Corp., the SJC held that there was no breach of fiduciary duty even when the majority could not show a legitimate business purpose for terminating a minority shareholder.  The SJC based its decision on the fact that the termination was not motivated by animus or personal financial gain by the majority.

Given the lack of clarity concerning a majority's fiduciary duties, it is not surprising that the rights of a minority shareholder/employee may also be unclear following termination.  A recent decision sheds some light.  In Selmark Associates, Inc. v. Ehrlich, a frozen out shareholder joined a competing company and solicited clients to follow him to the new company.  The SJC rejected the minority shareholder's argument that any fiduciary duty not to compete was automatically extinguished when he was terminated.  The SJC held that allowing a frozen out shareholder to "seek retribution by disregarding its own duties" would undermine long-standing fiduciary principles.  Thus, Selmark makes clear that a minority shareholder's fiduciary duty not to compete remains even after a "freeze out" by the majority.

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