Opinion
No. 4003532
November 13, 2006
MEMORANDUM OF DECISION
On June 21, 2005, the plaintiffs, Trans-Oceanic Motors, Ltd. (Trans-Oceanic), Thames Assurance Company, Ltd. (Thames), Michael D. Smith and Stanley A. Cardinal, the two surviving shareholders of Trans-Oceanic, Thames, and Five Thirty One, LLC (Five Thirty One), filed a three-count complaint against the defendant, Narcy Dubicki. Therein, the plaintiffs allege that the defendant, as executor of the estate of Michael A. Rakosky, wrongfully refused to sell back to Trans-Oceanic (count one), Thames (count two), and Five Thirty One (count three), the shares of each respective company held by Rakosky at the time of his death.
On August 31, 2005, the defendant filed an answer and a three-count counterclaim. In his answer, the defendant admits to the plaintiffs' right of redemption with regards to the Trans-Oceanic and Thames shares (counts one and two, respectively). As to count three, the defendant admits some allegations, denies others, and asserts two special defenses (unclean hands and failure to state a claim). In his counterclaim, the defendant alleges breach of fiduciary duty against the plaintiffs Smith and Cardinal in that they did not recalculate the value of Rakosky's shares in Trans-Oceanic (count one) and Thames (count two) as of the time of Rakosky's death on December 6, 2004. In count three, the defendant alleges breach of contract against plaintiffs Smith and Cardinal in that they have failed to remit to Rakosky's estate monthly payments owed to Rakosky under the Five Thirty One operating agreement.
On May 15, 2006, the plaintiffs Smith and Cardinal filed a motion to strike counts one and two of the defendant's counterclaim on the ground that these counts fail to state legally sufficient causes of action under either traditional or corporate law principles of fiduciary duty. The plaintiffs Smith and Cardinal have submitted a memorandum of law in support of their motion. On July 12, 2006, the defendant filed a memorandum of law in opposition. The matter was heard at short calendar on July 17, 2006.
DISCUSSION
"[A] counterclaim is a cause of action existing in favor of the defendant against the plaintiff and on which the defendant might have secured affirmative relief had he sued the plaintiff in a separate action . . . A motion to strike tests the legal sufficiency of a cause of action and may properly be used to challenge the sufficiency of a counterclaim." (Citations omitted; internal quotation marks omitted.) Fairfield Lease Corp. v. Romano's Auto Service, 4 Conn.App. 495, 496, 495 A.2d 286 (1985). In ruling on a motion to strike, "[w]e take the facts to be those alleged in the [counterclaim] . . . and we construe the [counterclaim] in the manner most favorable to sustaining its legal sufficiency." (Citation omitted; internal quotation marks omitted.) Commissioner of Labor v. C.J.M Services, Inc., 268 Conn. 283, 292, 842 A.2d 1124 (2004). "[I]f facts provable in the [counterclaim] would support a cause of action, the motion to strike must be denied." (Internal quotation marks omitted.) Greco v. United Technologies Corp., 277 Conn. 337, 347, 890 A.2d 1289 (2006).
In their memorandum of law in support of their motion to strike, the plaintiffs Smith and Cardinal argue that counts one and two of the defendant's counterclaim fail to state legally sufficient causes of action under either traditional or corporate law principles of fiduciary duty because the counts do not include factual allegations of fiduciary obligations with respect to the valuation of the Trans-Oceanic or Thames shares. More specifically, they argue that the defendant does not plead in his counterclaim that Rakosky placed a unique degree of confidence or trust in the plaintiffs; that they had superior knowledge, skill, or expertise regarding the valuation of the shares resulting in superiority or influence over Rakosky; or that they were under any duty to represent Rakosky's interests regarding the valuation of the shares. Finally, the plaintiffs argue that because the power to decide whether and when to valuate the Trans-Oceanic and Thames shares was vested in each respective company's shareholders, rather than in their directors or officers, corporate liability cannot be imputed to the plaintiffs.
The defendant counters that Rakosky, as one-third owner of each of the companies at the time of his death, was a minority shareholder, while the plaintiffs Smith and Cardinal, who owned collectively two-thirds of each of the companies, were majority shareholders and by virtue of that fact, the plaintiffs Smith and Cardinal owed the defendant fiduciary obligations. The defendant also argues that each of the companies was a "close corporation" whose shareholders owe one another the same fiduciary obligations as partners. As to the plaintiffs' claim that the valuation of the shares of each of the companies involves shareholder action only, the defendant argues that while the shareholders of each company set the price at which the shares were to be redeemed, the companies themselves would be bound to purchase the shares at the set price, making indistinguishable the distinction between shareholder and corporate action.
As to the existence of a fiduciary duty owed to the defendant by the plaintiffs, the counterclaim alleges in pertinent part that Rakosky, the plaintiffs Smith and Cardinal, and John P. Lanza (Lanza) were equal one-fourth shareholders in Trans-Oceanic and Thames; that Lanza's estate sold his one-fourth interest in each of the companies back to the companies at his death on October 19, 2004; and that by virtue of the relationships among Rakosky and the plaintiffs established by these facts, plaintiffs Smith and Cardinal owe Rakosky and his estate fiduciary obligations. The facts in the defendant's counterclaim, construed most favorably to the defendant, establish that at the time of Rakosky's death, the plaintiffs Smith and Cardinal were collectively majority shareholders, while Rakosky was a minority shareholder, in each of the companies. The defendant urges the court to follow Yanow v. Teal Industries, Inc., 178 Conn. 262, 422 A.2d 311 (1979) which, he argues, held that majority shareholders of a corporation owe a fiduciary duty to its minority shareholders.
John P. Lanza ("Lanza"), Rakosky, Smith, and Cardinal were founding shareholders of Trans-Oceanic and Thames. Lanza died on October 19, 2004. According to the defendant's counterclaim, after Lanza died, his estate sold his one-fourth share in each of the companies back to the company at the value set in each of the various agreements, leaving Rakosky, Smith, and Cardinal as one-third owners of each of these companies.
According to the defendant's counterclaim, at the time of Rakosky's death, Rakosky, Smith, and Cardinal each owned a one-third interest in each of the three companies, making each one individually a minority shareholder. The defendant argues, however, that because Smith and Cardinal collectively own a two-thirds majority in each company that they should be treated as majority shareholders.
In Yanow, the Connecticut Supreme Court stated that "[t]he rule of corporation law and of equity invoked is well-settled: the majority has the right to control [the corporation], but when it does so, it occupies a fiduciary relationship toward the minority, as much as the corporation itself or its officers and directors." Id., 283, quoting Pepper v. Litton, 308 U.S. 295, 311, 60 S.Ct. 238, 84 L.Ed. 281 (1939). This holding has been consistently followed by other courts in the state: See Banks v. Vito, 19 Conn.App. 256, 262, 562 A.2d 71 (1989) ("[a]uthority exists in this state for officers, directors, and majority shareholders to be held personally liable for breach of fiduciary duty") (emphasis added); Governors Grove Condominium Ass'n., Inc., v. Hill Development Corp., 36 Conn.Sup. 144, 155, 414 A.2d 1177 (1980) ("a dominant or majority shareholder bears the same fiduciary duty to the corporation and its minority shareholders as does a director") (citation omitted); Ribicoff v. Division of Public Utility Control, 38 Conn.Sup. 24, 36 n. 7, 445 A.2d 325 (1980), aff'd, 187 Conn. 247, 445 A.2d 324 (1982) ("[The] plaintiffs' minority interests [are not] subject to the unbridled whim of the majority. A dominant or majority shareholder bears a fiduciary duty to the corporation and its minority shareholders"). See also Perlman v. Feldmann, 219 F.2d 173, 175 (2nd Cir., 1955), cert. denied, 349 U.S. 952, 75 S.Ct. 880, 99 L.Ed. 1277 (1955) ("as dominant stockholder, [the defendant] stood in a fiduciary relationship to the corporation and to the minority stockholders as beneficiaries thereof").
Clearly, if Smith and Cardinal were majority shareholders of Trans-Oceanic and Thames, they would owe Rakosky the same fiduciary duties a corporate director owes shareholders. The facts alleged in the defendant's counterclaim indicate, however, that like Rakosky, Smith and Cardinal are minority shareholders, and only if their shares are pooled do they control a majority interest in the companies. There is ample justification and support, however, for holding that minority shareholders, who through their combined interest in the corporation are able to effectively control the corporation, should be treated as majority shareholders for the purposes of assessing fiduciary obligations towards other minority shareholders, especially when those shareholders work in concert for their joint benefit. See 18A Am.Jur.2d Corporations § 762 (1985) ("majority, dominant, or controlling shareholders, or a group of shareholders acting together to exercise effective control, are held to owe a fiduciary duty to the minority shareholders") (emphasis added); Weinberger v. UOP, Inc., 409 A.2d 1262 (Del.Ch. 1979) ("whenever . . . a group of shareholders who combine to form a majority . . . impose [their] will . . . upon the minority, such action gives rise to a fiduciary duty on the part of the majority shareholder[s]") (emphasis added). According to this line of reasoning, establishing the existence of a fiduciary duty only requires pleading that a group of minority shareholders collectively held a majority interest, and that they acted in concert for their joint benefit. According to the defendant's counterclaim, Smith and Cardinal held a two-thirds interest in Trans-Oceanic and Thames and exercised their power in concert in breach of their fiduciary obligations to the defendant. The defendant's counterclaim, therefore, alleges sufficient facts to establish that Smith and Cardinal owed the defendant a fiduciary duty.
The defendant's counterclaim also sufficiently pleads that Rakosky and the plaintiffs Smith and Cardinal were shareholders in a "close corporation." Although no Connecticut court has ever defined close corporation, in Donahue v. Rodd Electrotype Company of New England, Inc., 367 Mass. 578, 328 N.E.2d 505 (1975), the Massachusetts Supreme Court gave what is considered the standard definition of a close corporation: A close corporation is one "typified by: (1) a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation." Id., 586. See also 18 Am.Jur.2d Corporations § 38 (2004).
According to the defendant's counterclaim, after Rakosky's death, when the defendant argues that the value of the Trans-Oceanic and Thames shares should have been recalculated, each company had only two shareholders, plaintiffs Smith and Cardinal. Although the defendant's counterclaim does not specifically state that the shares were unmarketable or that Smith and Cardinal participated in management, "[a] [pleading] alleging breach of fiduciary duty by majority shareholders must be liberally construed with a view toward substantial justice." 18A Am.Jur.2d Corporations § 644 (2004). See Asylum Hill Problem Solving Revitalization Ass'n. v. King, 277 Conn. 238, 246, 890 A.2d 522 (2006) ("[m]oreover . . . [w]hat is necessarily implied [in an allegation] need not be expressly alleged") (citation omitted; internal quotation marks omitted). The elements of a close corporation can be reasonably inferred from the size of the business (three and then two shareholders), the fact that the company had the right to redeem shares of deceased shareholders, the capitalization of each of the companies (neither company had a total value in excess of three million dollars) and the type of business involved (all three businesses exist for a single purpose: to sell cars). These facts, construed in the defendant's favor, create the reasonable inference that Trans-Oceanic and Thames are close corporations.
As stated in the plaintiffs' complaint, Smith, Cardinal, and Rakosky chose to operate their businesses in the corporate rather than partnership form. The difference between corporations and partnerships that is most pertinent to this case is that the shareholders of a corporation generally are not liable to one another for how they act, while in a partnership, each partner owes a fiduciary duty not only to the partnership, but to other partners as well. See 18A Am.Jur.2d Corporations § 613 (2004) ("mere ownership of stock does not create a fiduciary relation between the stockholders"); 60 Am.Jur.2d Partnership § 123 (1985) ("[i]t is universally recognized that the relationship of partners is fiduciary"). In this case, the defendant would like the court to extend the fiduciary duties owed between partners in a partnership to Smith and Cardinal, shareholders in each of the companies.
The issue of whether members of a close corporation owe one another fiduciary obligations has never been squarely addressed by Connecticut's appellate courts. In two cases, the Appellate Court expressed doubt that such fiduciary obligations exist, but in both cases, the court opted to decide the matters without addressing the issue. See Lux v. Environmental Warranty, Inc., 59 Conn.App. 26, 39, 755 A.2d 936, appeal denied, 254 Conn. 949, 762 A.2d 902 (2000) ("[w]e are doubtful that a minority shareholder, even in a closely held corporation, is a fiduciary"); Falcone v. Watchman, Inc., 11 Conn.App. 218, 222 n. 3, 526 A.2d 550 (1987) ("[u]nlike shareholders, officers and directors even of a closely held corporation have statutory and fiduciary duties incident to their offices which cannot be delegated").
In spite of these remarks by the Appellate Court, there is substantial authority to suggest that, for purposes of determining the duties owed by shareholders towards one another, close corporations should be treated not like corporations, but like partnerships. "The resemblance of a [close corporation] to a partnership has led many courts to hold that . . . stockholders . . . owe one another substantially the same fiduciary duty . . . that partners [owe] to one another." 18 Am.Jur.2d Corporations § 36 (1985). This legal trend has found its way to some Connecticut courts. In Lopiano v. Gedney, the court stated that "[s]hareholders in a close corporation owe each other a fiduciary duty as do partners. As 50% shareholders in [the close corporation], [the parties] . . . owe each other a fiduciary duty." Lopiano v. Gedney, Superior Court, complex litigation docket at Stamford-Norwalk at Stamford, Docket No. CV X05 02 0191749 (Nov. 15, 2004, Rogers, J.), quoting Flight Servs. Group v. Patten Corp., 963 F.Sup. 158, 160 (D.Conn. 1997). In Morrow v. Prestonwold, Inc., Superior Court, judicial district of New Haven, Docket No. CV 00 0445844 (Dec. 20, 2001, Berdon, J.), the court stated that "[t]he question of what is oppressive conduct by those in control of a close corporation as its majority stockholders is closely related to what we agree to be the fiduciary duty of good faith and fair dealing owed by them to its minority stockholders." (Citation omitted; internal quotation marks omitted.)
Close corporations are in many instances more like partnerships in how the owners operate the business and how they conduct themselves with one another. A business that involves only two or three owners, each of whom owns an identical share in the company and who retains identical rights over the operation of the company, through corporate title or voting rights, is more like a partnership than a large, faceless, multi-state conglomerate. The companies involved here all revolve around a small, single-site enterprise (in fact, each of the three companies share the same address). As it would not do substantial justice to allow the choice of business entity to give a license to shareholders to subject another shareholder's interests in a close corporation to the unbridled whim of the collective majority, fiduciary obligations must be imposed on shareholders of close corporations. Therefore, since the defendant's counterclaim sufficiently pleads that Trans-Oceanic and Thames are close corporations, the defendant has sufficiently pleaded that Smith and Cardinal owe Rakosky and his estate fiduciary duties.
Finally, the plaintiffs Smith and Cardinal argue that since the valuation of the Trans-Oceanic and Thames shares involves shareholder action and not improper shareholder influence or control over the actions of directors or officers of the corporations, they cannot be held liable for breach of a fiduciary duty. In his counterclaim, the defendant pleads that Smith and Cardinal are collectively two-thirds owners of the companies, that they failed to recalculate the shares as of Rakosky's death, and that as a result, Smith and Cardinal received a windfall at the defendant's expense. "It is a thoroughly well-settled equitable rule that any one acting in a fiduciary relation shall not be permitted to make use of that relation to benefit his own personal interest. This rule is strict in its requirements and in its operation. It extends to all transactions where the individual's personal interests may be brought into conflict with his acts in the fiduciary capacity, and it works independently of the question whether there was fraud or whether there was good intention . . ." (Citation omitted; internal quotation marks omitted.) State v. Culhane, 78 Conn. 622, 628, 63 A. 636 (1906).
Admitting the facts alleged in the defendant's counterclaim, the defendant has stated a legally sufficient cause of action for breach of fiduciary duty. If, as the defendant's counterclaim alleges, Smith and Cardinal, while owing fiduciary duties to Rakosky, made a windfall by not recalculating the value of Rakosky's shares as of the time of his death, then Smith and Cardinal may be liable for making use of this fiduciary relationship to benefit their own personal interest. See 18A Am.Jur.2d Corporations § 778 (1985) ("in failing to permit a minority shareholder to obtain a monetary return from its stock ownership comparable to the benefits received by the majority shareholders, such majority shareholders breach their fiduciary obligation").
CONCLUSION
Counts one and two of the defendant's counterclaim contain facts legally sufficient to state a claim that Smith and Cardinal owed Rakosky fiduciary obligations; that these obligations extend to the valuation of the Trans-Oceanic and Thames shares; that Smith and Cardinal breached their fiduciary obligations by not recalculating the value of the share as of the time of Rakosky's death; and that Rakosky's estate was damaged thereby. As such, the plaintiffs' motion to strike counts one and two of the defendant's counterclaim is denied.