Business owners enter into stock-purchase agreements to facilitate buyouts upon certain triggering events, such as a shareholder’s death or divorce. But sometimes courts disregard these agreements, leaving shareholders vulnerable to paying (or receiving) an amount mandated by a judge who may not be familiar with the parties’ preferences or financial conditions.
Case in point
In a recent Minnesota Court of Appeals case (Piche v. Braaten), a minority shareholder had entered into a stock-purchase agreement with three majority shareholders in 2006. Four years later, his employment was terminated and the majority shareholders froze him out of the corporation due to “hostile and offensive misconduct in the workplace.” The stock-purchase agreement originally called for the minority shareholder to receive monthly installments of $8,333 over 15 years — a total of roughly $1.5 million — upon his death, divorce or bankruptcy. It also required the shareholders to revise the purchase price annually.
A Minnesota district court ordered a buyout of the minority shareholder’s interest as of Dec. 31, 2010. At the time of the court-ordered buyout, the minority shareholder had accrued a 22 percent interest in the company.
Both sides hired valuation experts. The plaintiff’s expert valued the minority interest at $2.176 million using the market approach. The defendants’ expert valued it at $1.296 million, also using the market approach.
The district court decided that the stock-purchase agreement didn’t apply because the parties didn’t anticipate a court-ordered buyout as one of its triggering events — and they never obtained updated appraisals in accordance with the stock-purchase agreement. After considering the conclusions of both expert witnesses, the district court valued the minority interest at $1.621 million, due immediately as a lump sum.
The appellate court upheld the lower court’s valuation of the minority interest. But it ruled that the district court should have allowed for monthly installment payments over 15 years, in accordance with the stock-purchase agreement. During trial, the majority shareholders testified that monthly installment payments were intended to preserve the company’s solvency.
Lessons learned
Stock-purchase agreements can’t premeditate every buyout scenario, especially court-ordered buyouts due to acrimonious shareholder or partner relations. These agreements are even less likely to be upheld when they’ve sat on a shelf for years, without being reviewed. Rather than rely on a value or buyout terms stipulated in a stock-purchase agreement, protect yourself with a valuation professional. He or she can help ascertain whether the valuation provisions of a stock-purchase agreement remain relevant in today’s marketplace and periodically provide updated appraisals.