Rubin v. Murray

Citations: 79 Mass. App. Ct. 64; 943 N.E.2d 949; 2011 Mass. App. LEXIS 365Docket: No. 09-P-1676

Court: Massachusetts Appeals Court; March 16, 2011; Massachusetts; State Appellate Court

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Katzmann, J. affirms a Superior Court judgment favoring plaintiff Merek Rubin, a minority shareholder and former corporate counsel for Olympic Adhesives, Inc., against corporate defendants Olympic and individual defendants John E. Murray, Jr., Stephen P. Hopkins, and Paul C. Ryan. Rubin claims that the individual defendants, controlling shareholders, paid themselves excessive compensation, depriving him of his rightful share of profits. Following a jury-waived trial, the judge ordered the individual defendants to reimburse Olympic for excessive compensation from 1995 to 2005, with funds to be redistributed among all shareholders.

Olympic is a closely held Massachusetts corporation formed in 1975 by the individual defendants, who had previously worked for Nicholson and Company, Inc. A dispute over control at Nicholson led to their departure and subsequent formation of Olympic, with a lawsuit filed against them by Nicholson’s John Murray, Sr. Rubin provided legal services to the defendants during the formation of Olympic and the Nicholson litigation, ultimately proposing a payment structure for his fees that included nonvoting stock in Olympic. This stock was valued at $2,750 for a ten percent interest, and the articles of organization were amended to establish a new class of nonvoting stock, class B common stock, identical to class A except for its lack of voting rights. The individual defendants accepted Rubin's proposal without seeking further legal counsel, trusting his expertise.

Holders of Class A Common Stock possess exclusive voting rights, with each share entitled to one vote. There was no indication that nonvoting stock was ineligible for dividends when declared. Amendments to the articles were approved by individual defendants. In 1976, Olympic established a profit-sharing plan allocating 20% of net operating income for distribution. Following a profitable year in 1977, Rubin advised the individual defendants to take merit bonuses to minimize tax liabilities, leading to bonuses of $5,000 for Murray and $4,000 each for Hopkins and Ryan. This practice of declaring bonuses continued. In 1978, Rubin borrowed $20,000 from Olympic against his stock, failed to repay it on time, and ultimately had the note forgiven in 1994 due to his relationship with the defendants.

Murray replaced Rubin as general counsel in 1981 after facing legal issues. Rubin ceased providing legal services for Olympic but remained socially connected to the defendants. Olympic thrived, and in 1990, a new profit-sharing plan was adopted, allocating one-third of net operating income to employee compensation, including the defendants. They also paid themselves additional compensation amounting to $14,925,000 from 1990 to 2005, on top of salaries and profit-sharing distributions, which the judge noted was proportionate to their stock ownership. 

In December 1998, Rubin expressed concerns to Murray about unfair distributions resembling disguised dividends. After his accountant reviewed Olympic’s records and following a formal demand from Rubin’s attorney in January 2000, Rubin filed suit on March 15, 2000, alleging that the defendants had breached their fiduciary duty by paying themselves excessive compensation. The court ruled in favor of Rubin, ordering the defendants to repay $5,806,000 in excessive compensation and legal fees paid by Olympic on their behalf. The defendants appealed, questioning Rubin's entitlement to challenge their compensation and the legality of the judge's remedy.

The 1975 fee agreement is scrutinized, with defendants arguing that Rubin, as their former attorney and an Olympic shareholder, lacks standing to contest their compensation. They claim Rubin breached his fiduciary duty by not disclosing a conflict of interest. However, the judge deemed Rubin's disclosures adequate and the transaction fair, referencing Pollock v. Marshall, which allows attorney-client transactions without independent legal counsel if the client is informed. The judge accepted Rubin’s assertion that he clarified his stock rights and advised the defendants to seek independent legal advice, which they chose not to pursue. The judge assessed the defendants' experience and knowledge regarding shareholder obligations, concluding that Rubin did not withhold significant information. Defendants cited Goldman v. Kane to argue for stricter disclosure requirements, but the judge found that case inapplicable since the transaction here was deemed fair. The judge confirmed Rubin’s entitlement to payment for his legal services, stating that the agreed stock value and other payments were fair compensation. The law permits attorneys to accept stock as payment, and all parties acknowledged the risks associated with the stock transfer, understanding that Rubin, as a minority shareholder, would benefit if the venture succeeded.

No fundamental unfairness was identified in the transaction where Rubin received ten percent of Olympic's stock as partial payment for legal services, with the judge applying relevant factors from Pollock v. Marshall to conclude that the 1975 fee agreement was fair and equitable. The defendants argued for a reevaluation of the agreement's reasonableness based on the current stock value, but the court noted that policy considerations for reviewing contingent fee agreements did not apply, as Rubin's payment was for services already rendered. The agreement's terms were negotiated when both the hours worked and results achieved were known, ensuring all parties had adequate bargaining power. The judge found the stock’s valuation of $2,750 for a ten percent interest reasonable, based on prior contributions made by the defendants. Additionally, the judge ruled that Rubin's cash compensation of $40,000 was insufficient, justifying the stock interest request. Concerns about the stock's value due to the company's potential failure did not render the fee excessive. Lastly, the interpretation of the articles of amendment regarding Rubin's stock ownership rights was clarified; the defendants' claim that he held no powers associated with his stock ownership contradicted reasonable contract interpretation principles.

In contract interpretation, the approach is to consider the contract in its entirety, ensuring a reasonable and practical reading that aligns with its language, context, and purpose. Individual terms should not be viewed in isolation; instead, the intent of the parties must be derived from a holistic understanding of the contract. The term "voting rights or powers" is contextualized by surrounding clauses, clarifying that it pertains to the nonvoting nature of Rubin’s shares. The amended articles of organization do not prevent Rubin from contesting excessive compensation or from sharing in profits.

Regarding compensation, the judge determined that the individual defendants' payments from 1995 to 2005 were excessively high, having taken nearly all profits after profit-sharing. However, the judge dismissed Rubin’s claim that all amounts exceeding salaries and profit-sharing were excessive, noting the defendants' relatively low salaries and their entitlement to reasonable bonuses. The judge aimed to ascertain reasonable executive compensation for a firm of Olympic’s size and character to identify excess compensation to be returned to the corporation. The defendants argued that the judge relied on insufficient evidence for determining reasonable compensation, which is a factual question subject to a clearly erroneous standard of review.

Factors for assessing reasonable compensation include the officer's abilities and the quality and quantity of services rendered, as well as compensation potentially linked to profits from their contributions. The judge had discretion in accepting expert testimony from Howard Gordon, who was qualified to assess fair owner compensation in closely held businesses. Gordon based his analysis on industry-standard publications and identified key factors for determining reasonable compensation, including the defendants’ roles in the company's success, annual sales growth, profitability, and their specialized skills contributing to the firm’s achievements.

The judge utilized Gordon's analysis but did not accept his salary figures, finding that the individual defendants were overcompensated at more than double the appropriate amount compared to similar companies. The judge determined fair compensation at approximately ten percent of Olympic's average annual net sales between 2001 and 2004, based on evidence that officer compensation typically ranged from four to seven percent of net sales, adjusted for the defendants' significant contributions. This approach was deemed a proper exercise of discretion, supported by expert testimony about average compensation for comparable firms.

The judge was not obligated to credit the defendants’ expert, Thomas Quinn, who argued that the additional compensation was reasonable due to the absence of IRS audits and the defendants’ roles. The judge noted Murray's vague rationale for compensating the individual defendants and highlighted that their additional compensation correlated with their stock ownership percentages rather than specific performance metrics. The court had the authority to question the reasonableness of the salaries and accept expert testimony on the excessiveness.

The judge's calculation of reasonable compensation was based on a consistent formula applied over a ten-year period, considering the defendants' positions, annual pay, and company profits. The judgment required the individual defendants to reimburse Olympic for excessive compensation, with Olympic responsible for any related taxes. The defendants' concerns about tax consequences were dismissed as they arose from their own improper actions in avoiding tax responsibilities. The judgment's remedy was framed within the context of an action for money had and received, emphasizing the equitable obligation to return unjustly retained funds.