Have you seen the latest?" Mike, the fifty percent owner of
a real estate investment firm asked his administrative assistant.
"That son-of-a-gun is charging the company for his
'administrative services,' work he agreed to do as part of
his general contribution to the business. He refuses to approve
payments for needed repairs, and he won't even talk about
selling the McDonald Building now that the market has peaked. I
can't out-vote him, and I won't allow him to sink my
investment. Is there anything we can do?" Mary responded,
"You know, I think you had better call Attorney Jones and talk
to him about filing to dissolve the company. It looks to me as
though Billy Bob is driving the company into the ground, and we
don't need to be part of that mess. Let's see what Mr.
Jones has to say."
The owners of closely held corporations sometimes disagree as to
the plans for the company's future, the relative worth of their
contributions and a host of other matters large and small. When
those disagreements result in an irretrievable break-down in
communication, and no owner can out-vote the other(s), things can
go badly for the company. The law in most states attempts to
address these difficult dynamics in a way that preserves both the
ownership stakes of the disputing parties and the underlying
business of the company. This is not a perfect process, however,
and it behooves business partners to anticipate the potential for
disagreement and plan accordingly.
The law allows one or more of the deadlocked parties to petition
the court to dissolve the company. Before a court will let an owner
or ownership group "pick up their marbles and go home,"
however, the owner(s) seeking dissolution must establish: 1. the
directors are deadlocked in the management of the company's
affairs; 2. the shareholders are unable to break the deadlock; and,
3. the company is threatened with irreparable harm. The court can
also order dissolution where the company's affairs can no
longer be conducted to the advantage of the shareholders. Finally,
a court can order dissolution where it finds that the directors or
those in control of the corporation acted, are acting, or will act
in a manner that is illegal or fraudulent.
Even where the court determines that the company can be dissolved,
there is still room for one or more of the shareholders who want to
perpetuate the company to do so. To be exact, those who wish to
continue the business can agree to buy out the dissenter. This
election must be made within ninety days of the request for
dissolution. The law makes an election to purchase the
dissenter's shares irrevocable unless the court determines
there is some good reason to set aside or modify the election. The
parties have sixty days after the election to purchase to agree on
a price for the departing shareholder's shares. By electing to
purchase the dissenter's shares instead of dissolving, the
company's operations are preserved.
If the parties cannot reach agreement on the price to be paid to
the dissenter, the court can determine the fair value of the
petitioner's shares as of the day before the date on which the
petition was filed or as of such other date as the court deems
appropriate. Fair value does not mean "fair market
value," but rather means what the dissenter's shares are
fairly worth---a determination potentially subject to significant
debate. Once the court determines the fair value of shares, it
orders their purchase for that price, upon such terms and
conditions it deems appropriate. The terms of purchase can include
provisions such as installment payments and/or security for
installment payments. The court can also allocate the fees and
costs associated with the valuation proceeding.
The problem with the law is that the parties can wrangle over the
fair value of a dissenter's shares only to have the result
unwound if within 10 days of the court's final determination of
the terms of purchase, the company votes to dissolve rather than
buy the dissenter's shares according to the terms established
by the court. The vote to dissolve puts the company right back
where it was when the petitioning shareholder first went to court
seeking dissolution. The only difference is that by the time the
court valuation process is completed, the litigation has usually
gone on for years, with all the costs associated with that
process.
While it is helpful that the law allows the owners of a dead-locked
corporation to get their investment back, there is lots of room for
controversy. For example, the meaning of "fair value" is
not fixed by the "market" as is "fair market
value." Even "fair market value" is debatable
when applied to the valuation of an asset without a ready market.
Of course, where there is ambiguity, the time and money it costs to
reach resolution can escalate. Likewise, finding capital or
diverting operating income to buy-out a significant stakeholder can
be challenging in the best circumstances. It is also unnerving for
the petitioning shareholder to know that the company could vote to
dissolve after a costly valuation process and the passage of time
that may further erode the company's value.
Owners in closely held business may therefore want to anticipate
the potential for disagreement in fashioning their business
agreements. They should, for instance, have a clear understanding
on issues like how and when they will be called upon to contribute
additional capital, the expectations for the ongoing commitment of
time and attention to the business, and how leadership of the
company will change over time. Second, they can agree to procedures
for resolution in the event of a deadlock. For example, they might
agree to a mechanism for valuing their interests such as by using a
multiple of the company's revenue averaged out over the prior
three years. They might also stipulate that in the event of
litigation over the value of a dissenting shareholder's
interest in the company, the loser will pay the attorneys' fees
and costs of the winner---a powerful incentive to be reasonable and
avoid litigation.
Scott Harris, is a director in the Litigation Department of McLane, Graf, Raulerson & Middleton, Professional Association.
Published in the New Hampshire Business Review
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