On March 26, 2015, Judge Dennis Saylor of the United States District Court for the District of Massachusetts, in an over 200-page opinion, decided a complex dispute between shareholders in a closely held cell phone tower business.
The origins of this particular tale of corporate disharmony date back to 2002, when John Strachan (“Strachan”) and Matthew Sanford (“Sanford”) decided to create a company to develop towers for the cell phone industry. Strachan and Sanford did not have adequate financial resources on their own, so they joined forces with two wealthy businessmen, Edward Moore (“Moore”) and Lawrence Rosenfeld (“Rosenfeld”). Together, the four men formed a corporation called Eastern Towers, Inc. (“ETI”).
Within just a few weeks of forming ETI, Moore and Rosenfeld proposed a revised corporate structure, which was to include the creation of a separate limited liability company – Eastern Towers, LLC (“ET”) – and an operating agreement for ET that would allow Moore and Rosenfeld to compete with ETI and excuse them from their obligation to present tower opportunities to ETI. Strachan and Sanford agreed to the new arrangement. From then on, ET and ETI existed in parallel with one another, though the parties freely transferred funds between the entities and generally treated them as a single business enterprise.
By 2003, it became apparent that ETI/ET needed additional funding. Moore approached TD Banknorth with a proposal for receiving a line of credit for the business. When TD Banknorth approved Moore for less than he hoped, Moore and Rosenfeld made no attempt to renegotiate with TD Banknorth on behalf of ETI/ET or seek funding elsewhere. Instead, Moore and Rosenfeld, without informing Strachan and Sanford, created a new entity, Eastern Properties, LLC (“EP”) and diverted a bank financing opportunity to that new entity.
In June of 2003, Moore and Rosenfeld withdrew nearly all of their capital from ETI and obtained Strachan and Sanford’s signature on documents which removed Strachan and Sanford as managers of ET. Although Strachan and Sanford were reinstated as managers the next day, in the intervening time, Moore and Rosenfeld caused ET to enter into a “Tower Purchase Agreement,” in which ET was required to sell towers to EP at less than half their fair market value.
Accordingly, throughout 2003 and 2004, EP purchased multiple towers from ET at less than half their fair market value. In addition, EP purchased towers from third parties which had been identified as corporate opportunities by ET. As ET/ETI was systematically stripped of its assets, it also became unable to pay Timberline Construction Company (“Timberline”), the vendor it used for construction of its towers. In addition, in February of 2004, Moore and Rosenfeld terminated Strachan purportedly for failure to notify them of an issue with a lease held by ET
Strachan ultimately filed suit against Moore and Rosenfeld for breach of fiduciary duty and other claims. Timberline also brought suit for damages based on its unpaid invoices. In a lengthy decision, Judge Saylor held that Moore and Rosenfeld had violated their fiduciary duties to ET and Strachan and had violated Chapter 93A with respect to Timberline.
The court began its analysis by explaining that the heightened fiduciary duties that apply to Massachusetts close corporations – duties of utmost good faith and loyalty to the entity and its members – also apply to closely held Massachusetts limited liability companies. This is significant because no Massachusetts court has explicitly stated such a holding, though it has been implied in various cases. The court also found that ET and ETI should be treated as a single enterprise for purposes of its analysis, based on the extensive commingling of funds between the entities and the parties’ failure to observe corporate formalities.
The court next addressed what effect, if any, ET’s Operating Agreement had on Strachan’s claims. The Operating Agreement granted Rosenfeld and Moore the right to engage in certain acts which would otherwise constitute a breach of their duty of loyalty to ET. Judge Saylor interpreted the language of the Operating Agreement narrowly and held that it did not constitute a broad waiver of the duty of loyalty. Instead, it only permitted Moore and Rosenfeld to compete with ET and excused them from presenting certain opportunities to ET. Importantly, it did not permit them to divert already-identified corporate opportunities from ET.
With these findings as background, Judge Saylor held that Moore and Rosenfeld breached their fiduciary duties to ET/ETI when they diverted the bank financing opportunity from ET/ETI to EP, when they withdrew over half a million dollars in capital from ET without adequately disclosing this to Strachan and Sanford, and when they caused ET to enter into the Tower Purchase Agreement and subsequently purchase towers from ET/ETI for less than half of their fair market value.
Interestingly, the court also found that Rosenfeld and Moore breached their fiduciary duty to Strachan individually when he was terminated for cause. Although the court acknowledged that Strachan’s failure to notify Rosenfeld and Moore of the lease issue constituted a “serious lapse in judgment” and, in different circumstances, may have authorized Rosenfeld and Moore to terminate Strachan without legal consequences, Strachan’s termination had to be viewed in light of Rosenfeld and Moore’s other conduct. The court ordered that Strachan be compensated for the loss of four years’ worth of his salary, which the court found was a “reasonable period of time” that Strachan could have expected to be employed.
Finally, the court found that Moore and Rosenfeld had engaged in unfair and deceptive practices in connection with their failure to pay Timberline. Although the court recognized that a mere breach of contract typically does not give rise to a Chapter 93A claim, it found that Moore and Rosenfeld had behaved deceptively by inducing Timberline to perform construction services, while simultaneously stripping ET of its assets.
This case is important because it demonstrates that, where the facts indicate that one or more parties have behaved deceptively and in violation of their fiduciary duties, courts will scrutinize any efforts to shield this conduct through creation of various corporate entities and exculpatory provisions. If you feel that you have been wronged by the actions of a fellow member of a close corporation or a closely held LLC, you should reach out to legal counsel for an identification of any potential claims.