Some months ago, in a post about the intersection of the at-will employment doctrine and fiduciary duty among shareholders in close corporations, I wrote:
The most common allegation of oppression by minority shareholders involves termination of employment by the controlling shareholders. The Court of Appeals in Matter of Kemp & Beatley noted that obtaining employment is often the main reason for becoming a shareholder in a closely held company that typically pays no shareholder dividends. As I’ve pointed out before, case law holds that the majority’s termination of the minority’s at-will employment does not give rise to a wrongful termination remedy under either a contract or tort theory, but it may be oppressive for purposes of seeking judicial dissolution where the shareholder joined the venture with the reasonable expectation of getting and keeping a job.
This principle is vividly on display in a recently decided case called Ambar v. Devington Technologies, Ltd., 2009 NY Slip Op 32373(U) (Sup Ct NY County Oct. 13, 2009), where the court refused to dismiss a petition for involuntary corporate dissolution brought by a minority shareholder whose employment was terminated by the controlling shareholders, notwithstanding at-will employment provisions in their shareholders’ agreement.
Devington Technologies Ltd. is a closely held New York corporation in the business of providing financial management computer software and programming to offices of medical providers. In 2002, founder Paul Ambar as 30% shareholder and Gershon and Tibor Klein, as combined 70% shareholders, executed a shareholders’ agreement containing fairly typical provisions for election of the shareholders as directors and officers, spending authorization limits, and a right of first refusal ("RFR") fixing stock value at $8,335 per share unless otherwise agreed unanimously.
After five years, due to their dissatisfaction with his job performance, the Kleins attempted to buy out Ambar. They proffered an amendment to the shareholders’ agreement reducing the board to two directors and replacing the existing RFR with a provision requiring Ambar to sell his 12 shares to the Kleins for a small fraction of the RFR share value. After Ambar refused to sign the amendment, the Kleins scheduled a special meeting of the stockholders and directors at which Gershon was elected president, Tibor was elected secretary, and Ambar was removed from Devington’s board of directors and his employment terminated.
Ambar then filed a petition to dissolve Devington under Section 1104-a of the Business Corporation Law, primarily alleging oppressive conduct based on the Kleins’ termination of his employment and their refusal to redeem his shares under the RFR at $8,335 per share. The Kleins opposed dissolution and moved to dismiss the petition, arguing that Ambar had no reasonable expectation of continued employment and a board position due to his at-will status under the terms of the shareholders’ agreement. The Kleins also contended they were justified in firing Ambar for poor job performance and for causing Devington to incur major business losses.
The court’s decision, by New York County Supreme Court Justice Marilyn Shafer, framed the issue as follows:
In opposition to the dismissal motion, Ambar details a different set of facts as to how and why Devington declined . . .. However, for purpose of the motions, it is not necessary for the court to evaluate or decide who or what triggered the corporate failures. It is sufficient to say that petitioner and respondents present diverse interpretations as to the factors that led the business to lose money, and submit dueling affidavits blaming each other for poor business decisions and incompetent day-to-day management. What is relevant to the court at this juncture is whether the petition sufficiently alleges that respondents, as the directors in control of Devington, engaged in conduct toward Ambar which entitles him to seek a judicial dissolution of the corporation.
Majority conduct is oppressive, Justice Shafer observed, when it "substantially defeats the reasonable expectations of minority shareholders," including the expectation to be actively involved in the company’s management and operation. "When majority and minority shareholders can no longer work together in their day-to-day decision-making and management, judicial dissolution becomes an option."
Justice Shafer concluded that Ambar’s petition (read here), while "not artfully drafted," sufficiently alleged grounds for dissolution based on the Kleins’ termination of his employment. In addition, the Kleins’ attempt to buy out Ambar’s shares "at a severely discounted price ($125.00 rather than $8,335.00 per share) supports his claim of mistreatment by the majority shareholders and states a ground for involuntary judicial dissolution."
Cases like Devington are an important reminder to owners of closely held businesses of the need to include fair and workable shareholder exit mechanisms in the shareholders’ agreement. The type of RFR used in Devington rarely succeeds, for at least two reasons. First, in the probable absence of any outside buyers for the minority interest, neither the minority nor majority can compel a buyout at any price. Second, the share price fixed at the outset almost always is doomed to obsolescence, either on the upside or downside. The shareholder agreements’ unanimity requirement for any change in the share price effectively deters any later adjustments as the value of the business grows — in which event the majority will resist adjustment — or, as in Devington, shrinks — in which event the minority will resist adjustment.
There are a number of techniques for overcoming the pricing problem, which in turn can ease mutual acceptance of a compulsory buyout trigger. One of the more popular ones is the use either of a single, independent business appraiser whose valuation is binding on the parties, or each side hiring their own appraiser. In the latter design, the agreement usually will provide for averaging the two appraisals if they fall within a specified range of each other or, if not, the appointment by those two of a third, independent appraiser whose valuation will either be determinative alone or is averaged with the first two, or is averaged with the closer of the first two.
None of the buyout mechanisms is perfect, but all are preferable to the uncertainty, expense and angst of dissolution litigation.