Imagine for a moment that you’re a shareholder in a closely held corporation. In most jurisdictions, that status as a shareholder obligates you to a heightened fiduciary duty to your fellow shareholders. Now imagine that your closely held corporation is in the real estate business, and one of your fellow shareholders sues the corporation for adverse possession of real property owned by the corporation. Surely that can’t be allowed, can it? Would you be surprised that a recent Massachusetts land court decision says that it is?
Background on a Most Interesting Adverse Possession Claim
The Szawlowski family has been in the potato farming business in Northampton, Massachusetts since 1910. The family business has grown, expanded, and changed over the decades, but as with many closely held businesses, generational changes and the inevitable disagreements that arise have resulted in significant litigation between nearly all parties involved.
One such case involved an adverse possession claim by Stanley Szawlowski, Jr. (“Stan Jr.) against Szawlowski Realty, Inc. (“SRI”) related to one of the parcels owned by SRI that Stan Jr. had lived in since childhood. The court’s decision lays out the detailed history between the parties, how SRI came to own the property, and how Stan Jr. came to own shares in SRI.
In Massachusetts, adverse possession requires four elements. First, the claimant must have continuous and uninterrupted use for at least 20 years. Second, the use must be open and notorious. Third, the use must be exclusive to the claimant, and fourth, the use must be adverse, meaning not permitted by the owner. The court’s decision here found that Stan Jr. had established all of the elements of adverse possession despite ownership changes. There was no real question that Stan Jr.’s family was the exclusive and continuous user of the residential property and that the prior owners, and ultimately SRI, knew about this use. However, the court’s reasoning is challenging to reconcile in a number of aspects related to the issue of the use not being permitted.
Specifically, Stan Jr.’s father “Stash” and his family moved into the residential farmhouse on the property in the mid-1980s after Stash and his three brothers had acquired the parcel (along with 3 other parcels) in 1985 as joint tenants with an undivided interest. At that time, the move was encouraged by Stash’s brothers. Several years later in 1990, the property was deeded by the brothers to SRI, which had been formed earlier that year. Stash and each of his brothers owned 25% of the shares of SRI. In 1999, Stash and his brothers argued about Stash’s use of the home and had a meeting to discuss him moving out, which Stash refused to do. The court relied on this 1999 timeline to establish that from that period forward, Stash’s use (and subsequently Stan Jr.’s use) was adverse and not permissive. The court gave little weight to the fact that the use of the property began as permissive, although the record did not indicate any real efforts by the brothers or SRI to remove Stash and his family from the property following the 1999 argument or to declare the property to be corporate property.
Shareholder Duties in Closely Held Corporations
While styled as an adverse possession case, the intersection of fiduciary duties and the adverse possession requirements was a critical aspect of the court’s analysis. Shareholders in Massachusetts closely held corporations owe each other the duty of utmost good faith and loyalty.[1]
The court relied on cases from Illinois and New Jersey to explain its analysis of these issues. The Illinois case, Perivoliotis v. Pierson, 167 Ill. App. 3d 259, discussed the requirement outlined originally in the New Jersey Case, Leigh vs. Howard, 87 N.J.L. 113 (Sup. Ct. 1915), that a president of a corporation can’t possess the corporation’s land adversely to the corporation, unless “upon proof of express notice to the board of directors that he is holding it adversely.” The Leigh court reasoned that “mere open notorious possession in such a case is not adverse; since it must be presumed that the president is holding for the company, to which he stands in the position of trustee.”
Perivoliotis expanded on this concept as well, and the court in the Szawlowski matter held that Stash’s argument with his brothers in 1999 and his insistence that the parcel was his and his alone, despite his role as a shareholder and officer of SRI, met this notice burden. Notably, however, the Szawlowski court did not fully address whether Stash had breached his fiduciary duties to the corporation at the same time as he was establishing his adverse possession claim. The court noted that the brothers and other family entities had filed various claims related to breaches of fiduciary duty (including by Stash) but that no specific breach of duty claim was raised related to the property at issue in the adverse possession discussion or Stash’s claim to that property.
The Massachusetts standard of loyalty, detailed most recently in Tocci v. Tocci, 490 Mass. 1, 15 (2022), prohibits fiduciaries from engaging in self-dealing. This occurs “when a fiduciary is positioned on both sides of a transaction or otherwise stands to benefit personally from the transaction. If a fiduciary engages in self-dealing without the approval of disinterested shareholders or directors, he or she bears the burden of proving that the transaction was intrinsically fair and did not result in harm to the corporation.”[2] In this case, it would have been interesting to analyze whether one shareholders’ exclusive use of a corporate asset is intrinsically “fair” to the other shareholders. Perhaps Stash received fewer distributions or other benefits from SRI. The record indicated that Stash and his family spent time and non-SRI funds to maintain the property.
Impact of the Decision
Since the court in Szawlowski did not conduct a full analysis regarding whether Stash had breached his duties of loyalty to SRI, confusion remains about the impact of this decision on real estate ownership in closely held corporations going forward. While the case is currently on appeal, it could impact on the operation of various closely held corporations in Massachusetts. How would the damages to the corporation be calculated in such instances?
Family business is tricky business, and the inevitable squabbles are a tale as old as time. But not all closely held corporations are family businesses, and outside of closely held corporations, commercial real estate acquisitions typically involve limited liability companies, partnerships, or other corporate forms under which the standards of care, penalties, and damages should be thoroughly discussed. How broadly should these findings expand into other such ownership types? Could a limited partner make a claim for adverse possession for some portion of their partnership’s real estate holdings? Could a trustee? If they meet the requirements for adverse possession and can claim ownership in real property, what are the remedies for the breach of their fiduciary duties under such circumstances? In the world of joint ventures and private fund formation, such terms are heavily negotiated and carefully crafted. The holding in Szawlowski highlights the importance of a thorough review and discussion of your proposed business arrangements with counsel, regardless of size.
[1] Donahue v. Rodd Electrotype Co. of New England, Inc., 367 Mass. 578, 586 (1975), quoting Cardullo v. Landau, 329 Mass. 5, 8 (1952).
[2] Tocci v. Tocci, 490 Mass. 1, 15 (2022) (internal citations omitted).
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