ROBERT G. DYNAN & others [Note 1] vs. EDWARD A. FRITZ, JR., & others. [Note 2]

WILKINS, J. This stockholders' derivative action involves claims that the defendants, who own a majority of the outstanding stock of the defendant F.S. Payne Co. (company), unfairly manipulated stock ownership to gain control of the company and unlawfully approved the company's purchase of the stock of the defendant Fritz on terms unfair to the company. Following many days of trial, the judge made findings and rulings and

Page 232

entered a judgment from which both sides have appealed. We granted the defendants' applications for direct appellate review.

We first describe the principal actors in this proceeding. The plaintiff Dynan, who owns 170 shares of stock in the company, was first employed by it in 1945, was elected a director in 1974, and served from 1974 to March, 1984, as a vice president and director. Dynan as director approved of the defendants' conduct of which he now complains in this action. The other seven plaintiffs, employees of the company, each own ten shares of its stock, except for Bishop, treasurer since November, 1982, and King, vice president for manufacturing since November, 1982, each of whom owns twenty-five shares. The defendant Fritz first became a company employee in 1960, is one of the company's three directors, owns 240 shares of stock in the company, and is a former president (from 1977 to 1982) and treasurer (from 1961 to 1982). Fritz purchased ten shares of company stock in 1961 and by various subsequent purchases had acquired 360 shares by July, 1973. He retired in January, 1983, and in 1983 sold 120 shares of stock back to the company in circumstances which, among other things, the plaintiffs challenge. The defendant Driscoll, an employee since 1952, is president of the company, one of its three directors, and the owner of 105 shares of company stock. The defendant Bloomquist, an employee since 1946, is the third director of the company, a vice president, and the owner of forty shares of its stock. The defendant O'Brien, an employee since 1953, has been the company's clerk since 1982, owns twenty-five shares of company stock, and has never been a director of the company. [Note 3]

We next summarize the significant facts which appear in the judge's detailed findings. The company is a Massachusetts corporation which, since 1906, has been in the business of manufacturing and selling elevators and elevator supplies. The

Page 233

greatest number of stockholders in the company at any time has been forty. The company's stock is not traded on any stock exchange. For many years, all company stock has been subject to a restriction on its transfer, requiring, in details not material to this case, that it must be offered to the company before it may be sold to anyone else. The company's policy, largely adhered to, has been to sell stock only to its employees and current stockholders. Commencing in 1954 as to certain shareholders and continuing generally to date, the company's sales of stock have been made subject to so-called buy-back agreements, pursuant to which the company may elect, within stated time limits, to repurchase stock upon either the death or the termination of employment of the employee-stockholder. All outstanding company stock is now subject to buy-back agreements. The formula in each buy-back agreement states the price at which the company may repurchase each share as "the higher of (1) 56% of the net book value thereof, ascertained as of the close of the calendar year last preceding the day on which the event occurs from which the right of election to purchase the shares arises; or (2) six times the average annual earnings per share for the five years ended at the close of said calendar year."

One major issue in this case is whether formula valuations per share should be based on the number of shares outstanding or on the number of shares issued (the total of the outstanding shares and treasury shares [that is, shares of stock, once outstanding, that the company has reacquired]). The defendant Fritz arranged to sell his stock to the company on his retirement at prices based on the number of shares outstanding. He argues that the buy-back agreement clearly so provides. The plaintiffs claim that under the agreement Fritz was obliged to sell his shares at a price using the number of shares issued and that the conduct of the company and others in dealing with the buy-back agreement since 1954 compels that interpretation.

Although generally accepted accounting principles would normally point to the use of the number of shares outstanding in determining the per share net book value of stock and although the company followed that practice in the years immediately

Page 234

after 1954, the company came to use the number of shares issued rather than the number of shares outstanding in determining buy-back prices. From 1954 to 1965, whenever the company repurchased shares it rather promptly sold them to employees and thus the difference between the number of issued and the number of outstanding shares was not significant. [Note 4] With one exception, the company has sold its stock to employees at the average cost to the company of its treasury stock (the cost of all stock held in the treasury divided by the number of shares of treasury stock). [Note 5] In 1965, the company repurchased 610 shares which it did not immediately resell. Concerned that the repurchase price under the buy-back agreement would fluctuate if the company continued to use the number of outstanding shares to determine the per share value under the buy-back formula, in late 1965 the directors voted that all treasury stock would be held as an investment, with the result that treasury stock was treated as an asset and the number of shares issued was to be used in the buy-back formula. The company made various stock repurchases from 1966 through 1970 using this method in each instance, although one retiring employee selling 120 shares contended that the appropriate calculation called for the use of the number of shares outstanding. During this time, offers of treasury stock to employees were not fully subscribed. At the end of 1969, for example, 1,883 shares were outstanding and 939 shares were held in the treasury. Under pressure from its accountants, who questioned whether in the circumstances the treasury stock was really being held as an investment, the company reclassified its treasury stock, effective December 31, 1970, from an investment to a deduction from capital and surplus on the liability side of the balance sheet.

We need not recite the details of the numerous stock transactions during the 1970's. The company's position continued

Page 235

to be that the number of shares issued was the appropriate number to use in computing the price to be paid per share under the buy-back formula. The company received some resistance on this point. In one instance, it was obliged to bring a lawsuit against a former president, Roland Marr, who claimed that outstanding shares should be used in valuing his stock on repurchase pursuant to the buy-back agreement. In the settlement reached in the Marr action in 1975 and otherwise, the use of the number of shares issued prevailed. There were, however, several repurchases after 1970 negotiated at prices not based, at least directly, on the formula in the buy-back agreement.

In 1982, the company agreed, after long negotiations and litigation, to repurchase the 226 shares of Milton Hickox, who had been president of the company. Hickox had suffered a stroke in early 1977, but arguably had been kept on as a company employee for many months. At the time of the repurchase of the Hickox stock, the plaintiff Dynan and the defendants Fritz and Driscoll were the members of the company's board of directors. After efforts to acquire the Hickox stock at lower prices had failed and Hickox had sued the company for a declaration that his stock was not subject to the buy-back agreement at all, all three directors had voted in December, 1981, to offer to purchase Hickox's stock at a per share price ($1,234.58), based on the number of shares outstanding. The Hickox lawsuit against the company was settled early in November, 1982, using the number of shares outstanding to arrive at the price the company paid for Hickox's stock. The judge was warranted in finding that the Hickox settlement was made at the higher price because it would set a precedent beneficial to each of the directors, particularly in establishing the price to be paid to Fritz on his upcoming retirement.

By this time, the defendant Fritz, the company's president, had attained the age of sixty-five, the company's normal retirement age. In August, 1982, Fritz, who then owned 360 shares of the 624 shares of stock outstanding, or about 58% of the stock, announced that he would retire on January 1, 1983. In November, 1982, the directors offered to sell 306 shares of

Page 236

treasury stock to employees. Of these shares, all of which were purchased, ninety went to the defendant Driscoll (increasing his holdings to 105 shares), ten went to the defendant Bloomquist (increasing his holdings to forty shares), and fifteen went to the defendant O'Brien (increasing her holdings to twenty-five shares). Neither Fritz nor Dynan purchased any of the 306 shares. Four plaintiffs became shareholders for the first time, and three other plaintiffs, who had owned company stock for a number of years, acquired additional shares. Thereafter Fritz owned 360 of the 930 shares then outstanding, or about 39% of the company's outstanding shares.

We pause here to deal with the defendants' challenge to the judge's conclusion that the sale of stock to the defendant O'Brien in 1980 [Note 6] and to the defendants Driscoll, Bloomquist, and O'Brien in 1982, was "undertaken to secure control of the company by the defendants" and was improper. [Note 7] We fail to see any justification for the judge's conclusion that the defendants undertook the 1982 sale to these three defendants (as part of the sale of 306 shares of stock) in order to secure control of the company. In late 1982, before the sale of additional stock to the other defendants, Fritz alone already controlled

Page 237

the company because he owned about 58% of its outstanding stock. The judge was warranted in finding that the other defendants cooperated and aided Fritz in his dealings with the company. On the other hand, the judge's conclusion that these stock sales were part of an attempt to secure control of the company cannot stand. [Note 8]

We come then to the transaction that the plaintiffs most particularly challenge -- the company's agreement to buy Fritz's 360 shares in three equal annual instalments coupled with the company's acceptance of the use, on each valuation date, of the number of shares outstanding in calculating the repurchase price. We start with what the parties call the Fritz amendment, a December 30, 1982, amendment of the buy-back agreement between the company and Fritz. This agreement did not in any way change the formula in the buy-back agreement for determining the purchase price. It provided that the company would repurchase 120 shares from Fritz on June 30, 1983, on June 30, 1984, and on June 30, 1985, valued in each instance as of the previous December 31. The Fritz amendment limited the additional amount of stock the company could issue (except for fair market value) prior to completion of the instalment repurchase, allowed Fritz to remain on the board of directors, and permitted his family health insurance plans to continue until all his shares were sold. In June, 1983, the

Page 238

company repurchased 120 of Fritz's 360 shares at a price of $2,202.18 a share, paying a total of $264,261.60.

The judge ruled that the Fritz amendment to the buy-back agreement was invalid because it secured an unfair advantage to Fritz at the expense of the company. He declared the Fritz amendment to be null and void. [Note 9] All parties challenge his conclusion. We agree with them. Putting aside the highly disputed question of the price to be paid (which was not covered by the Fritz amendment itself), the agreement was a fair and reasonable one. The company, which had recently paid $337,000 to Hickox to settle its dispute with him, deferred its obligation under the buy-back agreement to pay for the Fritz shares in full almost forthwith. The company's financial position benefited from the rearrangement. Fritz's anticipated service on the board of directors for an additional two and one-half years has not been shown to be detrimental or unfair to the company. Nor has the cost of providing group health insurance to Fritz and his family in exchange for his services as a director been shown to be unfair to the company. The defendants Driscoll and Bloomquist and the plaintiff Dynan, who with Fritz constituted the board of directors at the end of 1982, all voted in favor of the Fritz amendment.

Although the Fritz amendment did not affect the method for determining the price at which the company would repurchase the Fritz shares, the directors (including the plaintiff Dynan) all understood and agreed that the price would be determined using the number of shares outstanding, as had been done in repurchasing the Hickox stock. [Note 10] It is in the determination of

Page 239

the per share price, and not in the adoption of the Fritz amendment, that the problem lies.

This action was commenced on July 6, 1984, and had been threatened for some months. The company and Fritz decided to delay completion of the second and third instalments of their agreement. [Note 11] By a second Fritz amendment, therefore, the time for the second and third redemptions was postponed by one year and the valuation dates were also advanced by one year. The record does not indicate what has happened since the second Fritz amendment in June, 1984. [Note 12]

A major issue before the trial judge, as we have noted, was the proper interpretation of the buy-back agreement. Fritz argued that it unambiguously called for the use of the number of outstanding shares as the denominator in the determination of the per share repurchase price of his stock. The judge rightly rejected this contention. The provision that the "price to be paid for each share" shall be determined by a percentage of the net book value of each share or six times the average annual earnings "per share" did not compel the use of the number of outstanding shares in determining per share prices.

On the other hand, the judge erred in both of his reasons for concluding that Fritz's shares could properly have been repurchased under the buy-back agreement only at the lower per share price, one based on shares issued. The judge concluded that Fritz was collaterally estopped to deny such an interpretation of the buy-back agreement because the price per

Page 240

share expressed in the 1975 consent judgment in the company's action against its former president, Roland Marr, was based on the number of shares issued. Collateral estoppel or issue preclusion has no application here. Fritz was not a party to the Marr action. The corporation was not acting for him, nor he for it, in any way that would preclude him from now arguing his own view of the language of the buy-back agreement. See Rudow v. Fogel, 376 Mass. 587, 589 (1978). [Note 13]

The judge relied on a second and independent ground to conclude that the buy-back agreement provided for the use of the number of shares issued in determining the repurchase price of the company's stock. Deciding, we think correctly, that the agreement was ambiguous on the point, the judge turned to extrinsic evidence to explain its meaning. He looked at the company's conduct on the subject from 1965 to the date of the Fritz transaction and concluded that the company had consistently taken the position, except for the repurchase of the Hickox shares, that the per share repurchase price should be based on shares issued. [Note 14] The company's conduct goes a long way toward showing that, from at least 1965, the company and its officers and directors regarded the buy-back agreement

Page 241

as providing for the use of the number of shares issued, and the circumstances show that various selling stockholders, but not all of them, agreed or at least acquiesced in that view for whatever reason or reasons. In any event, what others may have accepted cannot properly be instructive on what the buy-back agreement between Fritz and the company meant. What Fritz did as an officer and director of the company in representing the company's point of view, as he was obliged to do in the Marr litigation and in other matters, provides no guidance as to what Fritz as an individual believed the buy-back agreement to provide.

Because the buy-back formula contained a significant ambiguity, the company and Fritz appropriately could consider what the purchase price for Fritz's stock would be on his retirement. What the company could not properly do, however, was to permit Fritz to dictate the purchase price. The judge properly concluded that the defendants Driscoll and Bloomquist were not disinterested participants in the matter. Because the interests of the company were not protected by any disinterested director, including the plaintiff Dynan, the question arises whether Fritz nevertheless met his burden of proving that the agreement on the repurchase price, which the judge warrantably ruled involved self-dealing by Fritz, was made in good faith and was fair to the corporation. See Winchell v. Plywood Corp., 324 Mass. 171, 175, 177 (1949). See also Principles of Corporate Governance: Analysis and Recommendations Section 5.02 (Tent. Draft No. 5 1986). The judge concluded that Fritz had not met the burden of proving that he satisfied his duty of loyalty, but the judge so concluded because of an interpretation of the purchase prices to be paid under the buy-back agreement with which we do not agree. [Note 15] The judge had

Page 242

no need, in his view, to determine whether, if under the buy-back agreement the repurchase price was fairly open for negotiation and determination, the prices selected were fair, viewed as of the time of the making of the arrangement, and whether the agreement was made in good faith. There was evidence tending to show that the "negotiated" repurchase prices appeared to be fair and that the other shareholders would benefit from such a sale. [Note 16]

On the other hand, the element of good faith was lacking from the Fritz negotiation, as the judge was warranted in concluding. [Note 17] In the context of the repurchase of company stock

Page 243

from an officer-director, good faith requires a full and honest disclosure of all relevant circumstances to permit a disinterested decisionmaker to exercise its informed judgment. See Winchell v. Plywood Corp., supra at 177-178; Principles of Corporate Governance, supra at Section 5.02 comment a, at 27 (Tent. Draft No. 5) (some opinions "have expressed the view, embodied in Section 5.02, that failure to make full disclosure affords an independent basis for the corporation to avoid the transaction"). Cf. G. L. c. 106, Section 1-201 (19) (1984 ed.), defining good faith as "honesty in fact in the conduct or transaction concerned"; DeBoer v. Anthony, 300 Mass. 403, 412 (1938). Because there was no good faith conduct leading to the arrangement, the judge was warranted in treating as void both the Fritz amendment and the repurchase prices determined by Fritz and accepted by the other directors. [Note 18]

Nevertheless, by returning the parties to the status quo as to Fritz's stock ownership, as the judgment below does, the company's problems are not solved. Equitable principles call for an attempt at resolution of at least some of them. Under the judgment in this case, Fritz, now no longer an employee, will continue to be a shareholder contrary to the company's practice (unless something has happened in the interim of which we are unaware). If the company's earnings have improved or at least stayed level in recent years, Fritz may reap a substantial benefit from the rescission of the Fritz amendment and the associated arrangement on the repurchase price. Rescission,

Page 244

moreover, by itself leaves the company without any basis for asserting its rights under the repurchase agreement. The dominance of Fritz prevented the company from making a good faith decision whether to assert its rights under its buy-back agreement with Fritz, as amended.

Fritz wants the agreement, as amended, to be carried out at his price. Perhaps a majority of the disinterested stockholders would now agree. Before rescission is ordered, the company's disinterested stockholders should be entitled to vote on whether to accept Fritz's stock on the terms agreed to by the company's directors on December 30, 1982, or on any modification of the arrangement more favorable to the company that Fritz may offer. [Note 19] In a sense, therefore, the arrangement with Fritz, modified by the Fritz amendment and governed by per share values determined using the number of outstanding shares, is to be treated as voidable at the option of the disinterested shareholders. Their decision not to accept the arrangement will in effect be an election by the company to rescind the Fritz amendment and to reject a repurchase of Fritz's stock. Whether the defendants Driscoll, Bloomquist, and O'Brien and the plaintiff Dynan (and perhaps others) are disinterested stockholders depends on circumstances, including recent events, not known to us. We leave that issue to the trial judge in fashioning a judgment on remand from this court. [Note 20]

Page 245

The judge ordered the defendants to pay their own counsel fees (and to reimburse the company for any counsel fees that the company had advanced). He declined to carry out the provisions of an indemnity by-law, which was in effect when the significant alleged harmful conduct in this case occurred (the purchase of the first 120 shares from Fritz). That by-law, which is set forth in the margin, [Note 21] provided for indemnity of attorneys' fees in any case against an officer or director unless he is adjudged "not to have acted in good faith in the reasonable belief that his action was in the best interest of the company." The judge concluded that it would be against public policy to permit the by-law to operate to cover the defendants. [Note 22] That policy judgment has already been made to the contrary by G. L. c. 156B, Section 67 (1984 ed.), which authorizes such a by-law in words which are virtually identical to what is stated in the by-law. Although such a by-law (as well as Section 67) is arguably too broad, and although Section 67 has been labeled "uniquely bad" (J.W. Bishop, Corporate Officers and Directors Indemnification and Insurance Section 6.29, at 133 [1981 & 1986 Supp.]), it is not appropriate, absent a valid constitutional challenge, for a court to disregard the authorization granted by Section 67.

Page 246

The judge ruled that he had not made a finding that the defendants acted in bad faith. We construe this ruling, in the circumstances, as a determination that, on the findings of fact, the defendants would be entitled to counsel fees pursuant to the by-law but for the judge's public policy determination to decline to permit the by-law to operate. [Note 23] The defendants are entitled to an order that the company pay their reasonable counsel fees and expenses. [Note 24]

We deal briefly with various other issues raised by the plaintiffs in their appeal. (a) The judge rightly decided that the plaintiffs, who approved them, have no valid ground to challenge the company's by-laws adopted in February, 1983. (b) The judge was also correct in dismissing Dynan's challenge to the company's proposal to retire him early. The judge was warranted in finding that there was a legitimate business purpose in the proposal, that the company was not injured by the decision, and that a derivative suit is not an appropriate forum in which to pursue any personal claim Dynan might have. (c) The judge was justified, in his discretion, in not enjoining potential misconduct by the defendants. (d) There is no error in the judge's decision not to direct Bloomquist to repay compensation he received after his planned retirement date and in his decision not to require the directors to repurchase Bloomquist's stock. There is no suggestion that Bloomquist's compensation was unreasonably high or that he did not continue to

Page 247

perform services for the company. The decision whether to repurchase stock under a buy-back agreement is a discretionary one for the directors. (e) The judge was amply warranted in concluding that Dynan was not an appropriate plaintiff in this action and that his conduct in voting in favor of various corporate action, such as the repurchase of Hickox's and Fritz's stock, was undertaken "to secure control of the Company for himself." The action properly can proceed, as the judge concluded, in the name of other stockholders. Dynan's motivation as the principal instigator of this action, challenging corporate action he approved of as a director, may have some bearing on the propriety of granting attorneys' fees to plaintiffs' counsel in this case. [Note 25]

On remand the judge should reconsider the question of making an award of attorneys' fees and expenses to the plaintiffs. He denied them counsel fees because he did "not find that the defendants acted in bad faith." Although the fact of the bad faith or good faith of a defendant in a stockholders' derivative action is a factor that the judge may consider in his discretion in passing on the fee question (see Smith v. Atlantic Properties, Inc., 12 Mass. App. Ct. 201, 211-212 [1981]), a finding of the defendant's bad faith is not essential to a lawful award of counsel fees in such an action. See Sagalyn v. Meekins, Packard & Wheat, Inc., 290 Mass. 434, 437, 440-441 (1935) (counsel fees and expenses awarded to successful plaintiffs in a stockholders' derivative action where defendants acted in good faith). The most important, but not dispositive, factor in deciding whether counsel fees should be awarded at all is whether the plaintiffs have benefited the corporation in some way by the result obtained in the lawsuit. The judge may not have all the necessary information to pass on the counsel fees question

Page 248

until after the stockholders' meeting is held, if one is held, to decide whether to vote to purchase Fritz's stock. [Note 26]

The judgment is vacated. A new judgment shall be entered declaring: (1) there is no basis for the rescission of either the sale of ten shares of stock to the defendant O'Brien in 1980 or the sales of stock in 1982 to the defendants Driscoll, Bloomquist, and O'Brien; (2) all defendants are entitled to payment of their reasonable counsel fees and expenses; (3) the 1983 by-laws may not be challenged by these plaintiffs; (4) the challenge by the plaintiff Dynan to the proposal to retire him early is not properly part of this shareholder derivative action; (5) the December 30, 1982, agreement between Fritz and the company, known as the Fritz amendment, shall be rescinded and Fritz shall repay to the company the amount ($264,261.60) he received in 1983 for his 120 shares of stock in the company (plus interest at the legal rate less the amount of dividends he would have received on those shares if he had not sold them) and the company shall return to Fritz a stock certificate representing 120 shares of stock in the company, unless, at a stockholders' meeting duly called and held within three months of the entry of the judgment after rescript, a majority of the disinterested stockholders (whose status shall be determined by the judge and described in the judgment after rescript), present and voting, shall vote to purchase Fritz's remaining 240 shares of stock, 120 shares to be valued as of December 31, 1983, and 120 shares to be valued as of December 31, 1984, under the buy-back agreement between Fritz and the company, using the number of shares of stock outstanding on each date, respectively, and without any obligation on the company to pay legal interest on such amounts (until the passage of thirty days from the date of the stockholders' vote) and with the right in Fritz to retain all dividends declared and payable prior to the date of the stockholders' vote to purchase; [Note 27]

Page 249

and (6) the amount, if any, which, in the judge's discretion, the plaintiffs shall receive from the company in payment of their reasonable counsel fees and expenses, with the right in the judge's discretion (a) to receive further evidence bearing on the question of the company's obligation to pay counsel fees and expenses of the plaintiffs and (b) to retain jurisdiction to decide this matter of fees after the stockholders' action, if any, on the repurchase of Fritz's stock.

So ordered.