Donahue v. Rodd Electrotype and the Rule Against Buying Back Only the Majority's Stock

A company bought its controlling owner's stock back for $800 a share. Four years earlier, it had offered the minority family as little as $40 a share for the same stock, and turned down the same $800 deal when that family asked for it. The Massachusetts Supreme Judicial Court called that a breach of duty in Donahue v. Rodd Electrotype Co. of New England, Inc., decided May 2, 1975, and the rule it wrote has governed close corporations in Massachusetts and influenced courts elsewhere ever since: if the company buys back stock from someone in control, it has to offer everyone else the same deal.

What follows is the case from the opinion, how the next year's decision limited it, and the clause that enacts the rule by contract in a state where no court will. The general duty is covered in Fiduciary Duties Business Partners Owe Each Other. This is general information; a lawyer in the owners' state should read the actual agreement.

Rodd Electrotype Company of New England made printing plates in Boston. Harry Rodd joined it as an employee in 1935, became a director the next year, and was its president by 1955, holding a controlling block of stock. Joseph Donahue joined in 1936 as a finisher of electrotype plates and, at Rodd's suggestion, bought 50 shares; he rose to vice president but, the court noted, 'never participated in the management aspect of the business.' The two families' stock stayed in roughly the same proportion for decades: the Rodds in control, the Donahues a minority with no say in running the company and no market to sell their shares into, since stock in a closely held company does not trade on any exchange.

Between 1965 and 1969 the company tried more than once to buy the Donahue family's shares, offering $2,000 to $10,000 for the lot, or $40 to $200 a share. The Donahues turned the offers down. In July 1970, with Harry Rodd about to turn 77 and wanting to retire, the company's two remaining directors, his son Charles and the company's clerk, voted to buy 45 of his shares for $800 each, $36,000 in total. Weeks later Euphemia Donahue, Joseph's widow, asked through her lawyer to sell her shares on the same terms. The company's clerk wrote back that it would not buy them and was not in a financial position to.

A regular corporation owes its stockholders the ordinary corporate standard of 'good faith and inherent fairness', the court said, but a close corporation is different in three ways that make that standard too weak: a small number of stockholders, no ready market for the stock, and substantial participation by the majority in running the company. Put together, those three facts mean a minority stockholder frozen out by the majority has nowhere to sell and no vote that matters. The court defined a close corporation by exactly those three traits, a definition still cited whenever a court has to decide whether a company counts as one.

The specific rule it drew is the equal opportunity rule: when the controlling stockholders cause the corporation to buy stock from one of their own number, they must cause the corporation to offer every other stockholder an equal opportunity to sell a ratable share at the identical price. It does not matter that Harry Rodd was retiring, or that the price was fair, or that the company genuinely could not afford to buy out everyone at once (the court noted the remedy could require Rodd himself to unwind the sale rather than force the company to find the cash). The breach was treating one owner's exit as a special transaction and everyone else's as not its business.

Donahue's strict language, that stockholders owe each other the finest loyalty and may not act out of self-interest at all, alarmed close-corporation lawyers: taken literally, almost any majority decision that happened to disadvantage a minority owner could be challenged. The court answered that the following year in Wilkes v. Springside Nursing Home, Inc., which is its own case study in Wilkes v. Springside Nursing Home and Freeze-Outs by Payroll: the majority keeps room to run the business, but once its action is shown to harm a minority owner, it must point to a legitimate business purpose, and the minority then gets to show the same purpose could have been reached a less harmful way. Donahue is the strict duty; Wilkes is the test a court actually applies to see whether that duty was broken. Read together, the two cases are why 'close corporation' and 'fiduciary duty' have been linked in Massachusetts law for fifty years.

Donahue binds only Massachusetts courts, but versions of it have been followed or cited with approval in several other states' close corporation cases, and the underlying problem is universal: a company that redeems one owner's stock and not another's is moving money out of the business on terms only one side got to negotiate. Delaware takes the opposite default position. 8 Del. C. § 160 lets a corporation buy back its own shares out of surplus with no statutory requirement to offer the same deal to every stockholder, and Delaware's courts have not adopted Donahue's equal-opportunity rule for ordinary corporations; an LLC agreement there can go further still and narrow fiduciary duties by contract (6 Del. C. § 18-1101(c)). So whether a Rodd-style buyback is a problem at all depends heavily on where the company is formed, which is exactly why owners should not rely on case law from a state they are not in and should put the rule in writing if they want it.

The pattern recurs any time a company has money to buy out one owner and not the others at the same time: a founder's retirement, a dying owner's estate being cashed out, a disgruntled partner being quietly paid to go. How to Buy Out a Business Partner covers the buyout process generally; the clause below is what would have stopped the Rodd transaction from happening on its own terms.

Donahue is one of 20 decisions summarized in Business Partnership Dispute Cases. The lesson travels past Massachusetts even where the rule does not: a buyback the other owners never got a chance at is the kind of transaction a court, or a jury of co-owners reading the company's books later, tends to notice.