United States: Massachusetts Federal Court Holds That LLC Operating Agreement Does Not Shield Defendants From Liability For Breaching Their Fiduciary Duties To Closely Held Corporations

Last Updated: April 28 2015
Article by Breton Leone-Quick

A recent decision by Judge F. Dennis Saylor of the U.S. District Court for the District of Massachusetts, Butler v. Moore, C.A. No. 10-10207-FDS U.S. Dist. LEXIS 39416 (D. Mass. Mar. 26, 2015), offers an example of how fiduciary duties can continue to govern the conduct of participants in a closely held corporation or LLC under Massachusetts law, even where parties claim that those duties have been abrogated by contractual agreement.  The decision offers a cautionary tale reminding shareholders and members in closely held companies of the fiduciary duties they owe to one another and to the company under Massachusetts law, and of the resulting requirement that they should be scrupulously fair and forthright, and carefully observe corporate formalities, in their dealings with one another.

Butler v. Moore will take an important place in the long line of Massachusetts decisions dealing with fiduciary duties in closely held entities. It offers a comprehensive overview of fiduciary duty law and carefully applies this law to a complex set of facts. In its breadth, depth, and human interest, it is comparable to previous landmark decisions in the field such as Demoulas v. Demoulas Super Markets, Inc., 424 Mass. 501, 677 N.E.2d 159 (1997). Judge Saylor's opinion is particularly noteworthy for:

(1) its detailed findings chronicling how the individual defendants progressively siphoned assets and opportunities from Eastern Towers through "an extensive pattern of deceit, concealment, and manipulation";

(2) its evaluation of the relationship between Eastern Towers, Inc. and Eastern Towers, LLC, holding that the two companies should be treated as a single entity in light of the failure to observe corporate formalities and their confused intermingling of operations and assets; and

(3) its close analysis of the intersection between the principals' fiduciary duties and the Eastern Towers, LLC operating agreement, concluding that the operating agreement did not insulate the defendants from liability.

The decision presents a clear warning to entrepreneurs and leaders of start-up businesses that, where a company is closely held, negotiations with other shareholders or members concerning corporate governance and related party transactions must be carried out with transparency, full disclosure, and good faith, consonant with the fiduciary duties incumbent upon them as shareholders, members, and/or directors of closely held companies under Massachusetts law.

The case concerns a dispute among shareholders of Eastern Towers, Inc., a small closely held Massachusetts corporation that was established in 2002 to develop and own cell phone towers.  Eastern Towers, Inc. was formed by two men with experience in the cell tower industry (Strachan and Sanford) and two experienced businessmen and investors (Moore and Rosenfeld), with the understanding that they would each be 25% shareholders.  Strachan and Sanford would work for the company and contribute their industry knowledge and contacts, as well as a cell tower they were already developing, while Moore and Rosenfeld would contribute their capital and general financial and legal expertise.

The ensuing history of the enterprise and the resulting litigation is complex and can only be briefly summarized here.  After Eastern Towers, Inc. was established, Moore and Rosenfeld proposed forming a separate limited liability company, Eastern Towers, LLC, in which they would have 60% ownership, while Strachan and Sanford would eventually own 40%, subject to vesting over time.  The LLC operating agreement also contained a provision in Section 5.2 allowing Moore and Rosenfeld to "engage or have an interest in other business ventures which are similar to or competitive with the business of the Company," and providing that they were not "obligated to present an investment opportunity to the Company even if it is similar to or consistent with the business of the Company" and could take the opportunity "for their own account."

Despite the defendants' contention that Eastern Towers, LLC owned and controlled Eastern Towers, Inc., the court found that the parties had never effected such a change in control, and that LLC and the corporation remained legally separate and independent of one another.  In terms of their operations, however, the court found that there was "substantial and confused intermingling" of the business activities, assets, liabilities, income, and expenses of the two companies.  Based on the evidence at trial, including the testimony of the principals and expert witnesses, the court concluded that Eastern Towers, Inc. and Eastern Towers, LLC should be treated as a single entity (collectively "Eastern Towers").

By the end of 2002 Eastern Towers was facing cash flow problems, and Moore sought additional financing from a bank with which he had an ongoing relationship.  The bank approved a loan, but Moore advised Strachan and Sanford that the bank's terms were unacceptable.  Moore and Rosenfeld then created yet another entity, Eastern Properties, LLC, controlled solely by them, and executed between themselves an agreement that enabled Eastern Properties to purchase completed cell towers from Eastern Towers at less than half of their true market value.  Meanwhile, Moore and Rosenfeld withdrew nearly all of the capital that they had contributed to Eastern Towers and, without informing Strachan and Sanford, arranged to transfer most of the bank's proffered financing to their new entity, Eastern Properties.  The end result was that Eastern Properties wound up with all of the towers developed by Eastern Towers, while Eastern Towers was left insolvent or "perilously close to insolvency."  Moore and Rosenfeld subsequently terminated Strachan, and proceeded to purchase additional cell towers and sites – many of them initially scouted or developed by Eastern Towers – for Eastern Properties or other companies they controlled without offering these opportunities to Eastern Towers.

Strachan filed suit against Moore and Rosenfeld and their companies.  After Moore and Rosenfeld put Eastern Towers, Inc. into bankruptcy, the bankruptcy trustee for Eastern Towers, Inc. joined Strachan as a plaintiff, as did a tower construction company that Moore and Rosenfeld refused to pay in full for its work for them.

After a 20-day bench trial, Judge Saylor issued a comprehensive and exhaustively detailed 205-page opinion in which he concluded that Moore and Rosenfeld had breached their fiduciary duties to Strachan, Eastern Towers, Inc., and Eastern Towers, LLC, and that Strachan had been frozen out of the enterprise.  He ordered Moore and Rosenfeld to transfer to the bankruptcy trustee 32 cell towers that they had purchased or diverted from Eastern Towers, awarded Strachan damages for his lost salary, and held that the construction company was entitled to double damages and attorney's fees for Moore's and Rosenfeld's unfair and deceptive business practices in violation of Mass. Gen. Laws ch. 93A.  He also imposed a constructive trust on the defendants as to the wrongfully diverted cell towers and any related real property, leasehold interests, rents, profits, accounts, and intangible property, and directed the defendants to render a "detailed accounting" to the bankruptcy trustee within 90 days.

Judge Saylor held that Eastern Towers, Inc. and Eastern Towers, LLC were both closely held entities and that Moore and Rosenfeld, as shareholders, directors, and/or members of these entities, owed fiduciary duties to them and their respective shareholders and members under Massachusetts law.   He concluded that Moore and Rosenfeld had breached those fiduciary duties by transferring towers from Eastern Towers for an unfair price or otherwise diverting tower investment opportunities from Eastern Towers without adequate disclosure to and approval by disinterested parties, i.e., Strachan and Sanford.

Judge Saylor further held that Section 5.2 of the Eastern Towers, LLC operating agreement did not absolve Moore and Rosenfeld from culpability for two principal reasons.  First, any effect that Section 5.2 might have had on Moore's and Rosenfeld's fiduciary duties was limited to Eastern Towers, LLC, and did not displace the fiduciary duties that Moore and Rosenfeld owed to Eastern Towers, Inc. and to Strachan and Sanford as its shareholders.  Second, while Section 5.2 stated that Moore and Rosenfeld were not required to "present" new investment opportunities to Eastern Towers, LLC, it did not authorize them to divert opportunities that had already been presented to the company.  The evidence supported this interpretation of 5.2 because "Moore and Rosenfeld specifically represented to Strachan and Sanford that they did not intend  to compete directly with Eastern Towers and that the provision was designed to protect their 'existing interests'" in other towers or tower companies.

The court's reasoning is consistent with and supported by the Massachusetts Supreme Judicial Court's pronouncements last year in Selmark Associates v. Ehrlich, 467 Mass. 525, 5 N.E.3d 923 (2014):  "[T]he existence of a contract does not completely relieve shareholders of their fiduciary obligations, and ... a claim for breach of fiduciary duty may lie when the contract does not entirely govern the rights and duties of the parties.... [T]o supplant the otherwise applicable fiduciary duties of parties in a close corporation, the terms of a contract must clearly and expressly indicate a departure from those obligations."  Id. at 538-539.

( Mintz Levin attorneys Michael F. Connolly and A. W. (Chip) Phinney, and Saul Ewing attorney Doreen Zankowski, served as trial counsel for the plaintiffs in Butler v. Moore.)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions