When the Iowa Supreme Court released its opinion last summer in Baur v. Baur Farms, Inc., the decision raised concerns over the impact it would have on buy-sell agreements in closely-held corporations. The concerns were generated as much by what the Court did not say as for what it did say. After stating the general principle to be followed in determining whether the actions of majority shareholders were oppressive to the minority, the Supreme Court sent the case back to the trial court to gather more information and decide if the majority shareholder had acted oppressively when it failed to honor the minority shareholder’s demand that his shares be purchased for more than the price stated in the bylaw provision establishing a right of first refusal. The trial court recently issued its opinion on the matter and, finding no evidence of oppression, dismissed the case.
To briefly recap Baur Farms, Inc. was organized in 1966 by two brothers, Merritt and Edward. Their sons, Jack, Dennis and Bob, received their shares in the corporation from their fathers as gifts and inheritance when they passed away.
Jack was not part of the farm operation. Until recently Bob had run the farm before turning day-to-day operations over to a nephew, a son of Dennis who died a few years ago. The original corporate bylaws contained a stock redemption feature at $100 per share. This provision was amended in 1984 to include a buyout provision at either a mutually agreed price or “book value per share of the shareholders’ equity interest in the corporation as determined by the Board of Directors, for internal use only, as of the close of the most recent fiscal year.”
After years of on again, off again negotiations, Jack, the minority shareholder, sued his brother Bob and their family farm corporation alleging oppression on the part of Bob for not purchasing Jack’s shares at the price he demanded.
The Iowa Supreme Court declared in its 2013 Baur decision that majority shareholders act oppressively against minority shareholders when the reasonable expectations of the minority shareholders are frustrated. Those expectations were described as an expectation to share proportionately in a corporation’s profits and net worth. In the key sentence the Court said “majority shareholders act oppressively when, having the corporate financial resources to do so, they fail to satisfy the reasonable expectations of a minority shareholder by paying no return on shareholder equity while declining the minority shareholder’s repeated offers to sell shares for fair value.” The Court also noted that unreasonable transfer restrictions like buy-sell agreements could be unenforceable.
After taking further evidence in the case, the district court considered whether Jack Baur’s reasonable expectations were denied him because (a) the corporation never paid a dividend and (b) the corporation/majority shareholder would not pay him the amount he demanded for his 26% interest in the corporation. The amount Jack asked for far exceeded traditional notions of book value and took only limited account of the tax effect on the corporation.
The non-payment of dividends was handled easily since Jack did not claim that the failure to pay dividends was oppressive conduct and even conceded that farm corporations like Baur Farms should not pay dividends.
The district court also concluded that the price Jack demanded for his shares of stock was not reasonably related to their fair value. The district court had no trouble declaring that it was unreasonable for Jack to expect more than book value as defined in the bylaws. This was especially true in this case because it was Jack who originally suggested the revised bylaw provision in 1984. But then the court added ambiguity to its decision by declaring that fair value means liquidation value.
In coming to this conclusion the district court observed that (1) receiving shares by gift or inheritance will impact the reasonableness of a shareholders expectations; (2) the determination of fair value has to be fair to all shareholders; (3) it is unreasonable to expect a corporation to sell assets or liquidate in order to meet a minority shareholder’s demand for payment; (4) bylaw restrictions, and by extension buy-sell restrictions, matter (5) the reasonableness of a minority shareholder’s expectations must be viewed in light of the burden that those expectations have on the corporation and the remaining shareholders (in this case the tax impact of the transaction and the burden of borrowing money to pay for the shares); and (6) Jack’s expectations can’t be different than Bob’s since they received the shares in the same manner, gift and inheritance, and Jack knew that his father and uncle wanted the business to continue so long as a family member wanted to farm it (that is, liquidating the corporation to satisfy his wish was not reasonable).
The one troubling aspect of the district court’s opinion is the meaning of “fair value.” The district court concluded that it means “the market value of [the corporation’s] assets, discounted to their liquidation value.” I think this means market value net of any tax effects. Does this mean that a buy-sell price restriction at book value or less is unreasonable? Earlier in the opinion the district court said that Jack could not reasonably expect a price other than book value because of the existence of the bylaw provision. So which is it?
The district court’s decision has been appealed to the Supreme Court so the last word has not been spoken. I hope the Court will address the book value versus liquidation value ambiguity, as well as what liquidation value means and whether it is the same as fair value? I don’t think the Court will address whether a buy-sell agreement that provides for payment of less than fair market value net of tax is enforceable or how far the majority needs to go to satisfy the demands of the minority for the fair value of their shares (selling assets, borrowing money, liquidating the company).
For now there is no reason to believe a buy-sell provision that is agreed to by the shareholders and contains a clear and unambiguous calculation of the price to be paid under certain circumstances will not be upheld by the courts, but there is reason to read for the next Baur court opinion very carefully.