Jay Sachetti joined Jeff O’Brien, partner at Husch Blackwell and Dyanne Ross-Hanson, president of Exit Planning Strategies talked about the market for mergers and acquisitions, exit planning opportunities for companies that don’t end up for sale and how companies can maximize their eventual sale price during an early October panel at the first Upsize on Tap event at Summit Brewing Co. in St. Paul.
When the state Legislature passed a law requiring employers to provide paid leave and safe time for employees, Justin Bieganek started hearing differing details from friends, colleagues and peers.
business builder law
by Doug Elsass and Kevin Maier
Most entrepreneurs who start businesses spend a lot of time thinking about potential markets, potential customers and potential profits. They don’t usually think about potential problems with their partners.
Maybe they should.
Lawsuits between shareholders of small, successful corporations are always emotionally and financially draining. But they are more common than you might think. Not every lawsuit can be avoided, but many business breakups could be made less painful if the owners reached agreements on important issues when times are good.
Many business owners don’t, for perfectly logical reasons. When a business is just starting, owners have their hands full making sure they can pay the bills. When the business becomes more successful, owners are even busier keeping customers happy. And it seems hard to imagine at that point that relationships among owners could sour.
But by not tackling the tough questions themselves, the owners of companies incorporated in Minnesota are effectively letting legislators draft their agreements — and legislators’ idea of a fair deal may not be the same as the owners’. Once litigation begins, however, it’s usually too late to reach different terms.
Three questions
Before that happens, all shareholders should reach agreements on these three important questions:
1. What is each shareholder’s status as an employee of the corporation? You might consider an arrangement where a shareholder-employee can be terminated on an affirmative vote by the shareholders or the board of directors. Or you could leave the discretion to the CEO. If you want to have some other arrangement, everyone should know exactly what it is.
2. If a shareholder leaves, voluntarily or involuntarily, what happens to the person’s shares? A typical buy-sell agreement is a contract that requires the departing shareholder to sell — and the corporation to purchase — all the shares. That protects both parties. A buy-sell agreement is also strong evidence (though it may not be conclusive) that the shareholders intended an at-will employment relationship.
3. What method should be used to value the shares? Since there isn’t a public market in shares of closely held corporations, the parties invariably will disagree over how much the shares are worth. Some methods favor the remaining shareholders by conserving the corporation’s capital. Other methods are more favorable to the departing shareholders.
If you don’t tackle these issues yourself, the default rules of the Minnesota Business Corporations Act (MBCA) will govern any future disputes.
The MBCA gives minority shareholders in closely held companies — those without controlling stakes in companies with fewer than 35 shareholders — powerful rights. The act also imposes important duties on all shareholders and gives courts broad discretion to issue orders when those duties have been breached.
Consider this scenario. You are the majority shareholder in a small corporation you own with three others, and you’ve taken none of the steps outlined above. You and two other shareholders agree that the fourth person is not carrying his weight. As the majority shareholder, you fire him.
He sues. First, he claims that his ownership gave him a reasonable expectation of continued employment. By firing him, you treated him in an “unfairly prejudicial” manner, triggering the remedies under Section 751 of the MBCA. He demands back pay.
More importantly, he also demands that the corporation buy back his shares. Since there is no agreement on a method for setting the value of the shares, he says the corporation must pay the price the shares would command if the company were sold as a going concern.
You counter that a fair price must include a discount for the fact that the shares are illiquid and the shareholder’s stock doesn’t represent a majority of the voting stock — no reasonable buyer, you insist, would pay the price the departing shareholder is demanding.
What would the outcome be? Like all legal disputes, the results would be extremely fact-specific. But without a clear agreement, Minnesota courts sometimes conclude that a shareholder invests in a small private company with the expectation of employment. If so, firing the shareholder may be “unfairly prejudicial” conduct under Minnesota law.
Courts also have discretion to force a buyout of a minority owner’s shares under Section 751. Though courts in some states require that the purchase price under these circumstances may be discounted to reflect the fact that the shares are illiquid and aren’t controlling, Minnesota law permits such discounts only when the purchase would otherwise be unduly burdensome to the corporation.
No blanket guarantees
Minority shareholders shouldn’t feel overly confident that Section 751 gives them blanket guarantees, however. While an investment may create an expectation of continued employment, it doesn’t always. The employee of a closely held corporation who receives stock as part of compensation, for example, probably doesn’t have a reasonable expectation that he or she now has a permanent employment contract.
Courts won’t always step in to force the corporation to buy back a minority shareholder’s shares, absent a buy-sell agreement. The court imposes that remedy when the majority shareholder treats the employee “prejudicially” — but not every unfavorable action is prejudicial treatment. As a minority shareholder, you could end up without a job and stuck with shares you can’t sell.
In short, the statute gives courts a lot of discretion in how they decide disputes between minority and majority shareholders. That’s good policy: These disputes are too varied for hard-and-fast rules. But by making the outcome less certain, that discretion also raises the litigation stakes.
[contact] Doug Elsass is a shareholder at Fruth, Jamison & Elsass in Minneapolis, practicing in business litigation: 612.344.9702; de*****@******aw.com; www.fruthlaw.com. Kevin Maler, a former journalist, is a law clerk at Fruth, Jamison & Elsass and a second-year law student at the University of Minnesota: km****@******aw.com
