State laws give voting power and, hence, management control, to majority shareholders in closely-held corporations. The minority shareholder can thus find herself without an effective voice in setting corporate policies for officer and employee compensation, finance, accounting, shareholder distributions, and a host of other decisions affecting the business. When this happens, the minority shareholder who feels she is being treated unfairly may desire to cash out her shares–for which no market likely exists–whether or not she has an available mechanism to do so, such as put rights or a buy-sell agreement.
Most states, including New York, long ago enacted judicial remedies for minority shareholders in cases of “oppressive” conduct by controlling shareholders. The New York statutory scheme, codified in §§ 1104-a and 1118 of the Business Corporation Law, authorizes the court to dissolve a closely-held corporation while giving the controlling shareholders the option to avoid dissolution by purchasing the petitioning owner’s shares for “fair value” which the court will determine if the parties cannot agree on a price. Many states including New York, by statute or common law, empower the court to compel a buy-out of the petitioner’s shares even if the controlling shareholder does not elect to purchase.
Delaware–which ranks 45th among the states in population but #1 in the incorporation of out-of-state entities–is not one of those states. Delaware, known for its management-friendly business laws, does not have a statute protecting oppressed minority shareholders of closely-held corporations. Except in cases of deadlock between two 50/50 shareholders, Delaware does not have a statute authorizing judicial dissolution of a closely-held corporation at the behest of a shareholder. Neither Delaware statute nor case law recognizes an oppressed minority shareholder’s right to be bought out.
The disadvantage of being a minority shareholder in a Delaware closely-held corporation came to the fore last week in Blaustein v. Lord Baltimore Capital Corp., C.A. No. 6685-VCN (Del Ch Apr. 30, 2013), in which Vice Chancellor Noble of the Delaware Chancery Court issued a 49-page opinion holding:
- the alleged failure by the controlling directors and shareholders to “negotiate in good faith toward a reasonable purchase price” did not breach any implied covenant of good faith and fair dealing arising from a provision in the shareholders’ agreement fixing minimum voting thresholds for board and shareholder approval for discretionary stock redemption, and
- the defendant controlling directors and shareholders owed no fiduciary duty to the plaintiff as a minority shareholder to accept her “reasonable” repurchase proposal.
Susan Blaustein controls approximately 17.5% of the voting stock in a closely-held Delaware subchapter “S” corporation known as Lord Baltimore Capital Corporation (“LBCC”). LBCC, which was formed around 1999 in the split-up of a predecessor “C” corporation, owns, develops and manages commercial real estate properties and has substantial holdings in securities and investment funds. Louis Thalheimer and members of his family own or control approximately 65% of LBCC’s voting stock and effectively have majority control of its board of directors.
According to Blaustein, she decided to invest in LBCC based on Thalheimer’s representations that there would be regular and substantial dividend distributions and that, after a ten-year waiting period, LBCC would purchase her shares at their full pro rata value. The repurchase was not memorialized in the shareholders’ agreement, Blaustein alleged, because Thalheimer claimed that doing so would jeopardize LBCC’s “S” corporation tax status as well as the tax-free treatment of the split-up transactions leading to LBCC’s formation.
The shareholders’ agreement included stock transfer restrictions including, in the event of a violation, a forced repurchase at roughly a 50% discount plus the obligation to cover any adverse tax consequences. The agreement also provided, in Section 7(d), that LBCC “may repurchase Shares upon such terms and conditions agreeable to the Company and the Shareholder who owns the Shares” subject to approval by a majority of the board or 70% of the shareholders.
The court’s opinion at pages 7-12 describes in detail Blaustein’s growing concerns over LBCC’s investment strategies and its ability to pay substantial dividends; over Thalheimer’s rejection of her proposals for an early buy-out; and over Thalheimer’s unwillingness to repurchase her shares after ten years at their pro rata value. In 2006, Thalheimer offered on LBCC’s behalf to purchase her shares at a discount of 52% of her pro rata share of the book value of LBCC’s net assets, which Blaustein considered punitive. Thalheimer insisted on the same discount even after the ten-year waiting period expired in 2009. Blaustein believed that Thalheimer was motivated by his personal concern not to undermine stock valuation discounts taken in gift tax returns for shares that had been gifted to younger members of the Thalheimer family. Blaustein also believed that Thalheimer never properly presented her buy-out proposals to LBCC’s board.
Blaustein brought suit in Delaware Chancery Court against LBCC and Thalheimer, asserting claims for promissory estoppel and breach of duty of good faith and fair dealing in connection with Blaustein’s failed efforts to effectuate a repurchase of her shares. In May 2012, Vice Chancellor Noble dismissed all of Blaustein’s claims except for breach of implied covenant in the shareholders’ agreement requiring repurchase proposals to be presented to the board (read decision here).
Following discovery the defendants moved for summary judgment dismissing the remaining claim based on evidence that LBCC’s board had fully considered Blaustein’s repurchase proposals. Blaustein opposed the motion and sought leave to amend her complaint to add supplemental claims for breach of fiduciary duty against all of the board members after they formally voted down her proposal for a stock repurchase at a 15% discount.
The Court’s Ruling
Vice Chancellor Noble’s legal analysis first addresses at pages 16-21 Blaustein’s surviving claim for breach of the implied covenant of good faith and fair dealing under the shareholders’ agreement. The court concludes that the claim is deficient based on the absence of evidence disputing the defendants’ factual showing that Blaustein had access to the board and that the board “was informed about the repurchase discussions and considered them.”
In that portion of his opinion Vice Chancellor Noble also concludes that the language of Section 7(d) of the shareholders’ agreement, the purpose of which was “to afford the parties bilateral discretion in determining whether to buy or sell their shares,” did not impose on the board an implied duty to negotiate “toward a reasonable purchase price”.
The lengthier and arguably more interesting portion of the opinion, extending from page 22 to page 48, discusses Blaustein’s proposed supplemental claims alleging that the board breached fiduciary duty when it formally rejected her repurchase proposal at a 15% discount. Blaustein alleged that the majority members of the board arrived at a “preordained” result driven by their own self-interest.
Vice Chancellor Noble writes that Blaustein’s proposed supplemental claims raise two key issues concerning “the interplay between contractual and fiduciary duties” and “what duties, if any, do controlling stockholders and the directors of a corporation owe to a minority stockholder when the minority shareholder seeks to sell her shares to the company” (pp. 27-28).
As to the first issue, Vice Chancellor Noble finds that because Section 7(d) of the shareholders’ agreement “does not create a specifically defined contractual right” and merely contemplates LBCC acting as it would when making a business decision, the provision does not foreclose Blaustein’s fiduciary duty claim alleging that the board has a duty to accept a reasonable purchase price.
But that’s as far as Blaustein’s claim gets. In the next section of his opinion, beginning at page 35, Vice Chancellor Noble examines relevant Delaware case law, including the Delaware Supreme Court’s decision in Nixon v. Blackwell, 626 A.2d 1366 (Del 1993). That decision, he writes, “confirm[s] that Delaware law does not recognize that a majority stockholder has a special fiduciary duty to minority stockholders in a closely-held corporation” (pages 41-42) and that “a controlling stockholder generally does not have a fiduciary duty to buy back a minority stockholder’s shares” (page 42).
Vice Chancellor Noble then offers a series of comments to show why, under the facts of Blaustein, the non-recognition of such fiduciary duty “makes sense.” Here are some of them:
- “[LBCC] and [Blaustein] were engaged in arms-length negotiations over the terms by which the Company might repurchase her shares–a process that likely mirrored the parties’ negotiations over the Shareholders’ Agreement.”
- “[Blaustein's] interest in obtaining a higher redemption price was in opposition to the interests of [LBCC] and its shareholders generally. That circumstance is not one that, by itself, would give rise to a fiduciary duty.”
- “All that [Blaustein] has alleged is that she has been deprived of a reasonable exit opportunity from her investment in [LBCC].”
- “Without more, granting [Blaustein] the right to be bought out would turn the relationship between majority and minority stockholders on its head. [Blaustein] cannot leverage her status as a minority stockholder to compel the Company to offer her favorable repurchase terms.”
- “In seeking to have her shares repurchased at a reasonable price, [Blaustein] is attempting to acquire–through fiduciary principles–an additional right that she was unable to obtain through an arms-length negotiation with the Thalheimer Shareholders.”
The concluding section of Vice Chancellor Noble’s opinion presses home the ultimate takeaway from the Blaustein case and its Delaware case forebears, namely, in the absence of statutory rules like those in New York and most other states protecting minority shareholder rights, minority shareholders in Delaware closely-held corporations who wish to preserve a right to redeem their shares must negotiate for that right in a shareholders’ agreement. Here’s how Vice Chancellor Noble sums it up:
[Blaustein's] predicament is not enviable, but she must live with the Shareholders’ Agreement for which she bargained. She had an opportunity to negotiate specific buyout terms. Her attorneys were sophisticated and well-regarded. The Court cannot read into the Shareholders’ Agreement obvious terms that she did not secure during the bargaining process. Nor can the Court, on these facts, utilize fiduciary principles to help her case.