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Recent MA SJC Noteworthy Decision, so to speak

Posted on Apr 19th, 2013

A recent decision by the Massachusetts Supreme Judicial Court is noteworthy for transactional practitioners:

In T. Butera Auburn vs. Williams, the Court held that a purchaser of a veterinary business was not entitled to withhold payment on a promissory note issued in connection with the purchase of defendant’s business.  The case involved the purchase of a veterinary clinic business from the defendant via an asset purchase agreement, where $800,000 was paid at the closing, the another $400,000 was payable via a promissory note over 15 years.  According to the decision, when plaintiffs discovered that the defendant was in violation of her covenant not to compete and other post-closing obligations, they brought suit and sought to hold back payment on the note to set off their damages.  Plaintiffs argued that they were excused from performance under the Note based on language on the APA that a default under a related transaction document (such as the Note) would be a default under the APA.  The Court rejected this argument, noting that this case involved the opposite scenario.  Here the breach occurred under the APA provisions, not the Note, and the Note did not contain a cross-default provision that would have potentially allowed the Plaintiffs to stop payment.  The Court did comment however, that if the plaintiffs could have shown that “the damaged business itself was supposed to generate the income from which the debt … was to be repaid, [the defendant] might well be estopped from obtaining judicially compelled acceleration on the basis that the Note was breached when payments were not subsequently made on time by the borrower.”

This case is a useful reminder that:

  • cross-default provisions and rights for setoff in the event of an indemnification or other claim should be included in Notes and other transactional documents
  • Language such as that quoted below may be helpful to add as an acknowledgment to a remedies section in the transaction documents to prevent a similar result

 


Recent decision by Massachusetts Supreme Judicial Court Strictly Construes Transfer Restrictions and Co-Sale Rights in S Corporation

Posted on Apr 19th, 2013

 

Since the 1974 landmark decision in Donohue v. Rodd, Massachusetts courts have held that majority stockholders in close corporations owe minority stockholders a fiduciary duty akin to that owed in a partnership. This type of duty has been relied up to protect minority shareholders from squeeze-out or freeze-out scenarios. It has also been used as an offensive tactic to argue for implied rights of shareholders that are not expressly provided in the corporate documents, such as the articles of organization, bylaws or shareholder agreements.

In Merriam, et. al. v. Demoulas Supermarkets, Inc., the Supreme Judicial Court refused to extend the duties provided under Donohue v. Rodd to restrict stock transfers that were not expressly restricted under the Corporation’s governing documents.

While a fiduciary duty may exist, the Court encouraged shareholders of close corporations to enter into a shareholder agreement or specify in the corporate bylaws “rights, protections, and procedures that define the scope of their fiduciary duty in foreseeable situations.” The Court held that good faith compliance with the specific terms will not implicate that fiduciary duty. “A claim for breach of fiduciary duty may arise only where the agreement does not entirely govern the shareholder’s actions.”

In this case the plaintiffs attempted to use the concept of fiduciary duty in a creative way to prevent the transfer of stock because the corporation was an S corporation and the transfer could blow the S election. After reviewing the shareholder agreement and bylaws, the Court held that the challenged actions fell within the scope of those agreements – which did not restrict such a transfer – and that the fiduciary duty was not implicated in this case.

The court also rejected the argument that the fiduciary duty could be used to create an implied right of first offer or co-sale rights on a transfer to a third party. Transfer restrictions are to be construed narrowly in Massachusetts, and the Court reasoned that had the parties intended to create such rights and restrictions, they would have stated so expressly in their shareholder agreement.

Certainly, this decision does not present any major news to most corporate practitioners. While it is nice to know that shareholder agreements are still given weight in Massachusetts, the key takeaway is the importance of having such an agreement in the first place. Close corporations, particularly those with employee shareholders, should be strongly encouraged to enter into detailed shareholder agreements to provide for situations dealing with transfers, rights of first refusal, preemptive rights and potential divorce and dissolution. Majority stockholders may feel some reluctance to spend money and time on such a document, when the protection is often for their fellow stockholders. However, as shown by this decision, not having such an agreement will subject everyone to the vague principles of applicable fiduciary duties, which could have wide-ranging and negative implications.

If you have any questions about this topic, please feel free to email us.


Recent Massachusetts Supreme Judicial Court decision summarizes Massachusetts Law on Statute of Limitations on Promissory Notes and Successor Liability

Posted on Apr 17th, 2013

If you look at promissory note in your form file, odds are that the signature line indicates that the note was signed “under seal.” Aside from custom, there are several reasons why this somewhat archaic language was included. The most important reason, at least in Massachusetts, was that the language elevated the note from a plain contract to a sealed instrument. This extended the statute of limitations relating to the Note from six years to twenty.

In 1998, in connection with the revision of Article 3 of the UCC, Massachusetts adopted G. L. C. 106, § 3-118, which provided for a uniform six year statute of limitations for all negotiable instruments. In its recent decision in Premier Capital, LLC v. KMZ, LLC, the Massachusetts Supreme Judicial Court held that Section 3-118 governs all negotiable instruments, sealed and unsealed. However, to the extent that a cause of action predates this adoption of law, the Court held that the law in effect prior to 1998 will apply. As there are probably few instruments still lying around that predate this adoption, odds are that we may start see the “under seal” language slowly disappear from these types of documents.

The other significant aspect of this decision is the Court’s concise restatement of Massachusetts law on successor liability. (The issue in the case was whether a promissory note could be enforced against KMZ, an entity that the plaintiff claimed to be a successor in interest to Max Zeller Furs, Inc., the party that signed the original note.)

First, in order to be deemed a “successor corporation”, there must be a transfer to that entity of “all or substantially” of another corporation.

If the first test is met, then to impose liability on the successor corporation, one of the following factors must also be met:

  • the successor assumes the predecessor’s liability expressly or impliedly
  • the transaction is a “de facto merger”
  • the succession is merely a continuation of the predecessor, or
  • the transaction is really just a fraudulent attempt by the predecessor to avoid liability.

Here, the Court affirmed the ruling in favor of the defendants, holding that there were no undisputed facts proving that Zeller transferred “all, or substantially all” of its assets to KMZ. While Premier argued that Zeller transferred its good will to KMZ, it could not show any actual agreement memorializing that transfer. The court also held that engaging in the same business and having the same stockholders, without meeting the transfer test, was not enough.

The take away from this case is that successor liability can only be established with a clear showing of facts within the established guidelines of the case law. Courts are not likely to find successor liability for purposes of summary judgment without undisputed proof of transfer of liability.

If you have any questions about this topic, please feel free to email us.


Massachusetts Supreme Judicial Court Holds Commissions to be Wages eligible for Treble Damages under the Wage Act

Posted on Apr 10th, 2013

A recent decision by the SJC holds that sales commissions can be wages within the meaning of the Massachusetts Wage Act, potentially subjecting employers to treble damages for failure to pay these amounts in a timely manner as required by the statute.   This case is called WEBER vs. COAST TO COAST MEDICAL, INC. et al.

The Court stated that while not all benefits fall within the term wages, commissions have been held to do so. The Court cited Section 148, which expressly states that holiday and vacation pay due under an agreement, as well as commissions that are “definitely determined” and “due and payable” to the employee, are wages within the meaning of the statute.  The Court approvingly cited earlier decisions, which reasoned the the legislative intent was “to apply the benefits of the statute to current-day employees as defined in the statute, including executives and professionals earning a substantial base salary plus commissions.”

This case serves as a clarification on this important point and a reminder to employers that commission plans should be in writing, and should clearly state any terms and conditions applicable to the amount and timing of the payments.

 

 


SEC Approves Crowdfunding Venture Capital Model

Posted on Apr 9th, 2013

On March 28th, FundersClub became the first online venture capital business to be approved by the SEC. The online investment platform received a no-action letter from the SEC essentially giving the company a thumbs up, legally speaking. This is significant across the board as players throughout the venture capital industry and companies searching for funds seek out creative fundraising sources to help bootstrap and fill a capital gap for smaller investments.

FundersClub resists the term “crowdsourcing,” but it does share some crowdsourcing traits. The platform allows investors who are accredited by the company to select companies for investment from a broad range of choices. The companies themselves are early-stage startups with business plans researched by FundersClub. In other words, the platform vets, curates and connects high quality investors and companies in need of funding, and does so while appearing as a single entity.

The issue of legality arose because FundersClub is not a registered broker-dealer. FundersClub simply responded that it was merely moving offline venture capital advising work into the online space. The SEC agreed with them, at least for now.

Also of significance here is the success of FundersClub despite the traditional need for relationships and networking in the venture capital arena. When it comes to doling out large sums of money, vetting matters. Investors have historically been reluctant or unwilling to make investments without personal interactions and referrals.

The victory of FundersClub highlights the ways that the VC landscape is shifting. Few investors today have the ability to maintain a truly diverse portfolio using personal connections. As outsourcing becomes more common investors feel more comfortable trusting vetting and other homework to specialists like FundersClub, and early-stage companies benefit from the exposure they get from the arrangement.

At this point FundersClub looks like it is here to stay. The National Venture Capital Association has accepted FundersClub this year as its first online member, and as of this writing FundersClub has helped its startups raise approximately $26 million. Whether other companies will jump onto the bandwagon and copy the FundersClub model remains to be seen, but we would expect this model to quickly grow and adapt as the market develops.

If you have any questions about this topic, please feel free to email us.