|Oregon State Bar Bulletin MAY 2010|
A Statutory Escape Route
By Susan Marmaduke
The February/March 2010 issue of the Bulletin discussed some of the challenges that face family-owned businesses and other closely held companies.1 Among them is the often thorny challenge of succession — the process of transferring ownership and control of the business from one generation to the next. Ideally, issues raised by succession can be managed through effective planning, counseling and mediation. A well drafted buy-sell agreement is an important element.
Without a buy-sell agreement, a departing shareholder has no right to payment for the value of his interest, and establishing a fair price for a redemption or cross-purchase can be difficult, particularly if relationships are strained. In many closely held companies, ownership and employment are inextricably intertwined. A sale of the company, therefore, is not simply a sale of chattel; it is in effect a sale of the shareholders and other employees into new employment relationships. And in fact, a sale of the company may not be a feasible alternative: Many closely held businesses are excellent places to work, but not at all attractive to outside investors. The sale of a fractional equity interest in a closely held company is even more problematic.
Thus, shareholders may feel locked into a strained and unproductive relationship. They may know they need to separate, but find themselves unable to disengage on mutually acceptable terms. As tensions mount and trust fails, deadlock or claims of waste or oppressive conduct may arise.
Traditional litigation of such shareholder disputes may be the legal equivalent of killing the goose that lays the golden egg. By the time the parties’ rights are finally adjudicated, the company may be damaged beyond repair: Working relationships are destroyed; legal fees and costs are crushing; and key employees are distracted from attending to the needs of the enterprise and its customers.
In 2001, the Oregon legislature a-dopted a statutory procedure intended to give warring shareholders an escape route. Part of the Oregon Business Corporation Act, it applies to certain types of disputes among shareholders in close corporations, a term which the statute defines as including all corporations without publicly traded shares. Under the statute, the filing of certain types of claims by a shareholder triggers a right by the corporation or other shareholders to buy out the complaining shareholder’s interest in the company for “fair value” — regardless of whether the complaining shareholder wants to be bought out. ORS 60.952. The filing of a qualifying claim is the triggering event, not the adjudication of that claim. As one of the authors of the statute, Robert C. Art, wrote:
For the plaintiff shareholder, filing a complaint, in effect, grants a “call” to the corporation and the other shareholders — an obligation to sell, even if the plaintiff might prefer a different outcome, such as continued share ownership with a judicial order compelling a dividend.2
The statutory grant of a “call” to the corporation and the other shareholders is triggered by the filing of a proceeding involving certain enumerated allegations, such as:
Deadlock impairing the corporation’s business and affairs;
Illegal, oppressive or fraudulent actions by the directors or those in control of the corporation;
Misapplication or waste of corporate assets.
The statute gives the corporation or one or more shareholders 90 days within which to elect to purchase the shares of the complaining shareholders. If the parties cannot agree on the price within 30 days after notice of such election, the court can stay the proceeding and determine the fair value and the terms of purchase of the shares. The court has the power to order the corporation to be dissolved if the purchase is not completed in accordance with the terms of the court’s order.
The statute is a potential trap for lawyers who inadvertently plead their way into a forced buy-out of their client’s equity interest in the company. It can, however, provide a relatively clear path for the company and the other shareholders to terminate the relationship with the complaining shareholder on terms established by a neutral decision maker.
A risk to the party electing the buy-out is that the election must be made without knowing the price or terms the court may set. “Shareholders may have developed perceptions of their company’s value based on a simple rule of thumb, such as a multiple of revenue. Appraisers, however, will often consider a company’s projected net cash flows as one of the most important factors in determining value,” says Serena Morones, a CPA and business valuation expert. “It may be prudent to engage an appraiser to conduct an initial low-scope assessment of value before deciding to elect a buy-out,” Morones points out. This should provide a preview of what the court may determine to be the “fair value” of the complaining shareholder’s interest.
Even a recent appraisal will not eliminate uncertainty, though. The meaning of fair value in the context of the statutory buy-out procedure is open to dispute. What value is “fair” necessarily depends on the circumstances of the particular case. Although fair market value is relevant to a determination of fair value, the two terms are not synonymous. In judicial decisions, the difference between fair value and fair market value is most often explored through the lens of discounts. Marketability discounts compensate for the lack of a recognized market for shares of a closely held business. Minority discounts recognize the relative undesirability of purchasing minority shares because of the lack of control. In other corporate contexts — often involving a determination of wrongdoing by the buyer — Oregon courts have deemed fair value to be a pro rata share of the company as a going concern, without discounts for either lack of marketability or lack of control. The special statute, however, permits a buy-out of the complaining shareholder by a party who may not have been an alleged wrongdoer, much less an adjudicated one. The role of discounts in the determination of fair value in this context is a potential area of disagreement.
Although the legislature did not define fair value in the statute, it did direct the tribunal to “[c]onsider any financial or legal constraints on the ability of the corporation or the purchasing shareholder to purchase the shares.” ORS 60.952(5)(a)(B). Requiring consideration of the corporation’s ability to pay for shares supports the legislative policy of promoting the survival of closely held corporations suffering through internal dissension. Since the statute directs the court to specify the terms of the purchase, including, if appropriate, terms for installment payments, interest, security for a deferred purchase price and other terms, the court may tailor those terms to the ability of the corporation or the purchasing shareholder to pay.
In summary, the statutory buy-out process is not without risk. It takes the price and terms of purchase out of the parties’ hands and puts them into the hands of a third party decision maker who must apply an ill-defined term, fair value.
On the other hand, the statutory process shifts the focus away from the mutual blame and antagonism inherent in fully litigating shareholder grievances and toward more objective financial considerations. And, perhaps most important, the statutory process assures that, at the end of the day, the parties’ affairs will be disentangled. It gives them an opportunity to move on to a more harmonious and productive future.
1 Cliff Collins, “All in the Family: Understanding the Dynamics of Family-Owned Businesses,” OSB Bulletin, February/March 2010.
2 Robert C. Art, “Shareholder Rights and Remedies in Close Corporations: Oppression, Fiduciary Duties, and Reasonable Expectations,” Journal of Corporation Law, vol. 28 (2003), pages 371, 415-16.
ABOUT THE AUTHOR
Susan Marmaduke is a lawyer in the Portland office of Harrang Long Gary Rudnick. Her practice focuses on business litigation and appeals.
© 2010 Susan Marmaduke