Allison v. Eriksson — Remedies Available to Minority LLC Members in Freeze-Out Mergers

Issue May/June 2019 May 2019 By Ian P. Gillespie
Business Law Section Review
Article Picture
Ian P. Gillespie

Under M.G.L. c. 156C, § 60(b), members of a Massachusetts limited liability company (LLC) who object to a merger are left with only one option: to resign and have their interest bought out by the majority. However, in Allison v. Eriksson, the Supreme Judicial Court (SJC) clarified that members opposing the merger of their LLC are entitled to additional equitable remedies beyond the scope of the statute if the majority member or members breached their fiduciary duties to the minority member in the process of effectuating the merger. 479 Mass. 626, 98 N.E.3d 143 (2018). In such a case, the courts have discretion to tailor equitable relief for the dissenting minority while also keeping in mind the best interests of the LLC, which may include rescinding the merger, or even modifying the operating agreement of the new LLC. This rule is applicable to “freeze-out mergers,” which occur when the majority members or member merge the business into a new entity with the purpose of eliminating, or “freezing out,” the minority.

The Case

Allison v. Eriksson involved two founders of a Massachusetts LLC, who were also its sole members. Eriksson controlled around 75 percent of the interest and Allison controlled around 25 percent of the interest since the founding of the LLC. The operating agreement required unanimous consent from the members to add any new members and for any action that would change a member’s ownership interest. After several years of operating, the LLC became depleted in cash. Eriksson, the majority member, refused to lend the LLC money, but was willing to invest money in exchange for equity. Allison, the minority member, similarly declined to lend money to the LLC, but also refused to allow Eriksson to invest funds in exchange for equity, because Allison did not want his own interest diluted. Eriksson suggested that they both invest money in proportion to their ownership interest or personally guarantee a bank loan. Allison rejected both of these suggestions as well.

At an impasse, Eriksson, without Allison’s knowledge, formed a new Delaware LLC that provided far fewer protections for minority members than the original Massachusetts LLC. Eriksson then forced the Massachusetts LLC to merge into the Delaware LLC and proceeded to purchase additional shares, which diluted Allison’s interest.

Allison filed suit to rescind the merger and restore his interest. Eriksson argued that Section 60(b) of the Massachusetts LLC Act, which applies to LLC mergers, does not allow for equitable remedies, but instead is limited to the “exclusive remedy” of buying out the opposing member’s interest. Conversely, Allison argued that the LLC Act does not limit the minority member’s remedy to a buyout when the majority breaches his or her fiduciary duty to the minority in the process of the merger. In addition, Allison contested the trial court’s refusal to rescind the merger, electing instead to modify the operating agreement of the new Delaware LLC, restoring Allison’s interest and rights.

First, addressing the scope of the statute, the SJC found that Section 60(b) provides that a buyout is the exclusive remedy for the dissenting member. However, Section 60(b) also requires the merger to comply with Sections 59-63 of Chapter 156C. In pertinent part, Section 63(b) places fiduciary and contractual duties on LLC members. The court concluded that because Eriksson acted in bad faith and clearly violated his fiduciary duties to Allison, the merger in this case was not in fact a “merger” under Section 60(b). This is because compliance with Section 63(b) is a “precondition” of Section 60(b). Therefore, Allison was not limited to the exclusive remedy of seeking a buyout, but could also seek and be entitled to certain equitable relief.1

The second half of the opinion addresses the trial court’s discretion in applying equitable relief. The SJC upheld the trial court’s order restoring Allison’s minority rights and interest to pre-merger status.2 But equally notable, the SJC affirmed the trial court’s refusal to rescind the merger.

The SJC reiterated that the proper remedy for a freeze-out merger “will put 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.” The court also noted the “broad equitable powers” courts have in specifying the appropriate remedy and that such a remedy must be in the company’s “best interest.”

In refusing to rescind the merger, the court considered: (i) the fact that Allison, a “sophisticated corporate attorney,” waited seven months after settlement negotiations to file suit; (ii) that Eriksson had already invested $500,000 in the Delaware LLC, complicating the divestment process; and (iii) that the merger was caused by Allison’s own breach of fiduciary duty in refusing to allow either member to invest in the cash-depleted LLC. All these factors together persuaded the court that it was not in the best interest of the LLC to rescind the merger.

Going Forward

The first half of Allison v. Eriksson provides litigants with a simple rule: In a contested merger where the majority member fails to satisfy his or her fiduciary duties, equitable remedies are available to the dissenting minority member. But if the majority member does not breach a fiduciary duty, then the minority member may only resign and seek distributions in proportion to his or her interest pursuant to Section 60(b) of the LLC Act.

The second half of the opinion demonstrates how equitable remedies are determined on a case-by-case basis, taking into account both: (i) the reasonable expectations of the minority member; and (ii) the best interests of the company. Importantly, as was the case here, these two factors do not necessarily go hand-in-hand. In Allison v. Eriksson, the SJC acknowledged that rescinding the merger, amending the operating agreement and adjusting the interests of the members are potential remedies. A review of cases demonstrates the broad range of other equitable remedies available, such as returning dividends to the minority; Zimmerman v. Bogoff, 402 Mass. 650, 661 (1988) and Crowley v. Communications for Hospitals Inc., 30 Mass. App. Ct 751, 768 (1991); recovery of lost profits; O’Brien v. Pearson, 449 Mass. 377, 388 (2007); or reinstatement or back pay if that member is also an employee. Wilkes v. Springside Nursing Home Inc., 370 Mass. 842, 854 (1976). See generally, Rosenhouse, 39 A.L.R. 6th 1. Interestingly enough, a buyout, the very remedy that the minority member sought to avoid in Allison v. Eriksson, is generally not available as an equitable remedy in a close corporation because buyouts often place the minority members in a better position than they would have been absent the wrongdoing. Brodie v. Jordan, 447 Mass. 866, 872 (2006).

Ian P. Gillespie is an associate at Aceto, Bonner & Cole PC in Boston. He is a member of the Business Law Section Council at the Massachusetts Bar Association. Gillespie works primarily in complex civil litigation, administrative law, employment law, real estate disputes and business litigation.

.................................................

1. Notably, the court found that the remedies for LLCs in mergers should be interpreted the same as business corporations under Chapters 156B and 156D. 
2. However, the court remanded the case to the trial court for further explanation on why it increased Allison’s interest to 5 percent.