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Kelleher v. Squires

Superior Court of Massachusetts, Suffolk

January 21, 2016

Madeline Kelleher et al. Each Derivatively as Shareholders of the Squires of Hanover, Inc. [1]
Paul Squires et al Opinion No. 132630

Filed Date January 26, 2016


Kenneth W. Salinger, Justice

The Squires of Hanover, Inc., (the " Corporation") is a closely held Massachusetts corporation. Defendant Paul Squires (" Squires") owns one-half of the Corporation. Plaintiffs Madeline, James, Catherine, and Evelyn Kelleher (the " Kellehers") together own or control the other half. Squires has been the only officer and director of the Corporation since the Kellehers' father died in 2011.

The Kellehers filed this action against Squires on behalf of the Corporation. They claim that Squires has been grossly negligent in running the restaurant that is the Corporation's sole business and that he thereby caused the Corporation to suffer economic damage. They also claim that Squires has converted to his own use monies or profits that belong to the Corporation. The Kellehers were required to name the Corporation as a nominal defendant.[2]

The Corporation has asked the Court to appoint a panel of independent persons pursuant to G.L.c. 156D, § 7.44(f), to determine whether this derivative action is in the Corporation's best interests. The Court DENIES this request because it appears to be merely an attempt by Squires to circumvent normal corporate governance and because the Corporation has not made even a prima facie showing that this action against Squires is not in the Corporation's best interest.

1. Legal Background

" [A]s a basic principle of corporate governance, the board of directors or majority of shareholders should set the corporation's business policy, including the decision whether to pursue a lawsuit." Halebian v. Berv, 457 Mass. 620, 626, 931 N.E.2d 986 (2010), quoting Harhen v. Brown, 431 Mass. 838, 844, 730 N.E.2d 859 (2000). " However, where a shareholder claims that a corporation's directors or officers have engaged in wrongdoing that has injured the corporation, " a shareholder may, " in certain circumstances, . . . initiate a civil suit on behalf of the corporation against the directors or officers. A suit brought in this manner to vindicate a right of the corporation is known as a derivative proceeding" and is governed by G.L.c. 156D, § § 7.40 to 7.47. Halebian, supra, at 625.

The revised Massachusetts Business Corporations Act, which took effect on July 1, 2004, [3] " imposes a universal demand requirement on shareholder derivative suits." Id. By statute, a corporate shareholder may not " commence a derivative proceeding" on behalf of a corporation unless it makes " a written demand . . . upon the corporation to take suitable action" and either (a) " the demand has been rejected by the corporation, " (b) 90 days have elapsed with no response from the corporation (this period is extended to 120 days if the corporation chooses to submit the demand to a vote of the shareholders), or (c) " irreparable injury to the corporation would result by waiting for the expiration of such 90-day or 120-day period." G.L.c. 156D, § 7.42. " As a result, in Massachusetts, there is no longer a futility exception to the demand requirement, even if the board members are not independent and disinterested." Johnston v. Box, 453 Mass. 569, 578 n.15, 903 N.E.2d 1115 (2009).[4]

If one or more shareholders bring a derivative proceeding on behalf of a corporation after complying with the statutory demand requirement, the corporation may force dismissal of the action--and thereby regain control over the decision whether to pursue or forego the lawsuit--if the corporation can show " that the shareholders or an appropriate group 'has determined . . . that the maintenance of the derivative proceeding is not in the best interests of the corporation.'" Halebian, 457 Mass. at 626, quoting G.L.c. 156D, § 7.44(a).

The corporation itself may make such a decision, and thus compel dismissal of the derivative action, by acting through either: (1) a majority vote of independent directors who reach this conclusion " in good faith after conducting a reasonable inquiry upon which its conclusions are based, " (2) a majority vote of a special litigation committee of the board, consisting of at least two independent directors who were appointed by a majority of independent directors and who reach this conclusion in good faith and based upon a reasonable inquiry; [5] or (3) a majority vote of shareholders, excluding any shares owned or controlled by someone " who has or had a beneficial interest in the act or omission complained of or other interest therein that would reasonably be expected to exert an influence on that shareholder's or related person's judgment if called upon to vote in the determination." G.L.c. 156D, § 7.44(a) & (b).[6] The Supreme Judicial Court has construed § 7.44 as requiring that the derivative action must be dismissed if the corporation has determined that the suit is not in its best interests in the manner provided for in the statute, whether it makes that decision before or after the derivative proceeding has been commenced. See Halebian, 457 Mass. at 627-33.

The statute also gives a court the power to " appoint a panel of 1 or more independent persons upon motion by the corporation to make a determination whether the maintenance of the derivative proceeding is in the best interests of the corporation." G.L.c. 156D, § 7.44(f). A court has broad discretion in deciding whether or not to appoint such a special panel. The governing statute says that a court " may appoint" such a panel. G.L.c. 156D, § 7.44(f). " The use of the word " may" denotes a discretionary power." Provencal v. Commonwealth Health Ins. Connector Auth., 456 Mass. 506, 513, 924 N.E.2d 689 (2010). If the court appoints such a panel, and the panel determines that the derivative action is not in the corporation's best interest, the action must be dismissed unless the plaintiff shareholders prove either that the panel did not act in good faith or that its conclusion does not reflect " a reasonable inquiry." See G.L.c. 156D, § 7.44(a) and (f).

2. Discussion

The " independent panel" that a court may establish under G.L.c. 156D, § 7.44(f), to pass judgment on a shareholder derivative action is an unusual creature. The Business Corporation Act " declares as a general principle of corporate governance that '[a]ll corporate power shall be exercised by or under the authority of, and the business and affairs of the corporation shall be managed under the direction of, its board of directors[.]" Halebian, 457 Mass. at 625, quoting G.L.c. 156D, § 8.01(b). At common law and now by statute, where a majority of the directors are accused of malfeasance, but " the majority stockholders are not the [alleged] wrongdoers, " those shareholders not alleged to be complicit in the alleged wrongdoing have the power to decide whether or not the corporation should pursue a lawsuit against the company's executives for allegedly breaching their duties to the corporation. S. Solomont & Sons Trust v. New England Theatres Operating Corp., 326 Mass. 99, 114, 93 N.E.2d 241 (1950); accord G.L.c. 156D, § 7.44(b)(3). Thus, if a court establishes an independent panel to determine whether a derivative proceeding is in the corporation's best interest, it is taking away power to exercise business judgment that is normally reserved to the board of directors and shareholders and giving it to strangers.

The Legislature established no standards for deciding whether or when a court should appoint such an " independent panel." No reported Massachusetts decision, of an appellate or trial court, addresses the issue. Chapter 156D " is based on, but not identical to, the American Bar Association's Model Business Corporation Act (2002)." Halebian, 457 Mass. at 625. Although the " independent panel" provision codified at G.L.c. 156D, § 7.44(f), now appears in similar statutes in other states, [7] there appear to be only two reported cases nationwide in which an independent panel was appointed, and in both cases that appointment was agreed to by all the parties. See FCR Realty, LLC v. Green, 60 Conn.L.Rptr. 764, 2015 WL 5134536 (Ct.Sup. 2015) (Calmar, J.) (denying motion to appoint independent panel), ...

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