In Allison v. Eriksson, 479 Mass. 626 (Mass. 2018), a majority LLC member undertook a merger in violation of his fiduciary duties.  In a case of first impression, the Supreme Judicial Court of Massachusetts held that equitable remedies, in addition to the statutory remedy of distribution under the Massachusetts LLC Act, are available to dissenting members in those circumstances. 

In 1999, defendant Elof Eriksson wanted to start a business based on technology he had developed while working at a hospital.  He and plaintiff, W. Robert Allison, formed Applied Tissue Technologies, a Massachusetts LLC (the “Massachusetts LLC”), to pursue the business.  Eriksson contributed $45,000 for 75% of the business and Allison contributed $15,000 for 25%.  Their shares in the Massachusetts LLC stayed roughly the same over time.  

By 2012, the Massachusetts LLC needed money.  Eriksson would not lend additional funds to the company unless he received additional equity.  However, Allison refused to have his interest diluted unless the investment came from an outside investor, refused Erikssson’s proposal that they both invest money and refused to use his personal assets to secure a loan for the company.  Likely frustrated, Eriksson engaged counsel and formed a plan to attempt to purchase Allison’s share of the Massachusetts LLC and if he refused, merge the Massachusetts LLC into a new company.  Eriksson did not inform Allison about his engagement of counsel or his plan.  

On May 6, 2012, Eriksson offered to purchase Allison’s membership interests, and Allison refused.  Thus, at the end of the month, Eriksson caused a new Delaware LLC to be created and executed an agreement and plan of merger with the Massachusetts LLC.  After the documents were executed, Allison learned of the merger and of Eriksson’s engagement of counsel for the first time.

Eriksson quickly purchased $250,000 of preferred shares in the new Delaware LLC. Allison was given the opportunity to purchase enough preferred shares to maintain his ownership interest in the new entity, but he declined. Instead, Allison challenged the propriety of the transactions.  Eventually, through further purchases by Eriksson, Allison’s interest in the new Delaware LLC was diluted to just above 3%.  Allison continued to dispute Eriksson’s actions, and eventually filed suit.  

Eriksson did not dispute that the merger breached his fiduciary duties to Allison.  Conducting the merger in secret, which both diluted Allison’s interest and removed the minority protections built into the Massachusetts LLC agreement, was plainly a breach of fiduciary duty.  The question before the court was the remedy.  

Where a minority member objects to a merger, but the merger proceeds anyway, Section 60(b) of the Massachusetts Limited Liability Company Act controls.  See Mass. Gen. Laws ch. 156C, § 60 (b).  That Section provides that “[t]he exclusive remedy” of an LLC member whose LLC “has voted to consolidate or to merge with another entity under the provisions of [Sections 59-63 of the Massachusetts LLC Act, governing mergers], inclusive, who objects to such consolidation or merger, shall be the right to resign as a member and to receive any distribution” of his interest.”  Id. (emphasis added).  Given that language, the question was whether a merger in violation of fiduciary duties, such as the one at issue, “may still be characterized as a merger ‘under the provisions of’” the Massachusetts LLC Act “and therefore be covered by the exclusive remedy provision of § 60 (b)” or whether equitable remedies were also available.  Allison, 479 Mass. 636-37.  

The court found that the merger was not “under” the Massachusetts LLC Act merger provisions for several reasons.  First, the court found it “anomalous” to treat a merger as “under” those provisions when it was conducted in violation of the fiduciary and other duties identified in those provisions.  Second, the court had previously held that a freeze-out merger in technical compliance with the Massachusetts corporation statutes “does not divest the courts of their equitable jurisdiction.”  Id. at 637.  Third, the court “conclude[d] that if it was the Legislature’s understanding that merger would provide a unilateral means for majority members to extinguish fiduciary duties and freeze out minority members from LLCs, it would have said so expressly.”  Id.  In other words, if the Legislature wanted a merger to result, ipso facto, in the expulsion of a dissenting member of an LLC without the possibility of equitable relief like unwinding of the merger -- even where the merger violated fiduciary or other duties -- it would have said so.

Thus, the court held that “where the merger of an LLC constitutes a breach of fiduciary and contractual duties in contravention of [Section § 63(b)], Section 60(b) does not prevent the courts from providing the dissenting members with an equitable remedy other than the statutory right of distribution.”  Id. at 638.  In defining the remedy, the proper one puts the minority member “in the position he would have been in had the freeze-out not occurred, and compensates him for the denial of his reasonable expectations.”  Id.  That does not necessarily mean rescission.  "A judge need not order rescission of a freeze-out merger if it would not be in the best interest of the company."  Id.

At Novack and Macey, we have extensive experience advising shareholders involved in closely held company disputes, as well as advising companies on how to avoid disputes in the first place. For more information about our services, please contact John Haarlow at 312.419.6900 or jhaarlow@novackmacey.com.