The next time someone tells me they’re preparing a shareholder buy-sell agreement using a fixed price memorialized in a so-called Certificate of Value, I’m going to tell them to rename it a Certificate of Legal Fees, and I’m going to tell them to read the court’s opinion in Sullivan v. Troser Management, Inc., 2013 NY Slip Op 01634 (4th Dept Mar. 15, 2013).
When intelligently prepared and implemented, buy-sell agreements among co-owners of closely-held businesses are extremely useful and effective devices to preserve business continuity and financial stability while providing a fair exit mechanism for withdrawing owners and fair compensation for the estates of deceased owners, often funded by cross-purchase plan life insurance policies.
The pricing aspect of a buy-sell agreement is perhaps its most critical feature. There are three pricing methods in general use: (1) fixed price, that is, a dollar amount usually found in an appended Certificate of Value or Schedule; (2) formula price, which can take any one of many forms based on the company’s financial metrics and/or the withdrawing owner’s historic compensation; and (3) a process-based approach involving one or more appraisers who will value the selling owner’s interest in the company as of the date of the triggering event (death, notice of withdrawal, etc.).
On the problems frequently associated with fixed-price buy-sell agreements, no one says it better than business appraiser Chris Mercer in his book, Buy-Sell Agreements for Closely Held and Family Business Owners (p. 80):
In my opinion, for most situations, fixed-price buy-sell agreements should be avoided like a contagious disease. However, if you have a fixed-price agreement, you must have the discipline to update the price periodically. And you must amend the agreement to include a workable appraisal process in the (likely) event that you fail to update it.
The Sullivan Case
The Sullivan case decided last week takes Mercer’s admonition to new heights. Not only did the shareholders in Sullivan fail to update the Certificate of Value price, as occurred in the ill-fated DeMatteo case that I wrote about last year (read here), they never agreed upon a value for the company’s shares in the first place! As a result of the omission, and several other complicating factors, a lawsuit to enforce the buy-sell remains unresolved 10 years after it was brought.
The plaintiff, Thomas Sullivan, in 1986 joined the defendant, Troser Management, Inc., as its director of sales for the operation of a ski resort. Sullivan and the company entered into an agreement that promised Sullivan he would be issued shares equaling 18% of the equity in Troser if he remained employed until 1991.
A contemporaneous buy-sell agreement granted the company the option to repurchase the stock if Sullivan ceased to be employed by Troser. The buy-sell agreement stated that the purchase price shall be “an amount agreed upon annually by the Stockholders as set forth on the attached Schedule A” or the last agreed upon value, increased or decreased by reference to the company’s book value if the last agreed value was older than two years. No Schedule A was attached to the agreement — not in 1986, not ever.
Sullivan left Troser’s employment sometime after 1991, apparently without his 18% stock interest having been formalized much less repurchased. For reasons not disclosed in the court’s opinion, not until 2003 did Sullivan file a lawsuit seeking specific performance of the stock issuance and buy-sell agreements.
The First Three Appeals
Troser initially moved to dismiss the complaint as time barred. The trial court’s 2003 order denying the motion, and ordering issuance of shares to Sullivan, was affirmed on appeal to the Appellate Division, Fourth Department, in 2005 (read here). In that same appeal, Sullivan successfully overturned that portion of the trial court’s order that also ordered performance of the buy-sell agreement at a price derived from a buy-out of a prior shareholder.
The lawsuit was just getting warmed up. In 2006, upon Troser’s application for summary judgment the trial court directed a stock repurchase for about $110,000, determined by prorating the value of Troser’s parent corporation among the parent’s three subsidiaries. Sullivan appealed and, in 2006, the Fourth Department vacated the trial court’s order, finding that there were issues of fact concerning the valuation method (read here).
Three years later, the trial court denied Sullivan’s motion for partial summary judgment seeking an order determining that his shares be valued on the basis of his percentage interest in Troser’s assets “in the event” that Troser exercises its option to purchase his shares. Sullivan cited in support Lewis v. Vladeck, Elias, Vladeck, Zimny & Engelhard, 57 NY2d 975 (1982), in which New York’s highest court approved a net-asset valuation for the buy-out of a law firm partner under the buy-sell provisions of a shareholders’ agreement that expressly contemplated a future agreement among the partners — never reached — as to valuation methodology.
Once again, Sullivan appealed, and once again, in a 2010 ruling (read here) the Fourth Department disagreed with the lower court and granted Sullivan’s motion, finding that Sullivan had established as a matter of law that, since “the purchase price of his shares . . . cannot be ascertained in accordance with the terms of the agreement,” it should be based on his prorated percentage of the company’s assets.
The Latest Appeal
Last week’s decision, arriving on the tenth anniversary of the case, is an appeal from the trial court’s ruling in late 2011 finding that Troser had in fact exercised its option to repurchase Sullivan’s shares, but also denying Troser’s summary judgment motion fixing a purchase price of about $184,000 computed at book value in accordance with the net-asset approach used in the Lewis case.
The Fourth Department unanimously affirmed the denial of Troser’s motion to fix the purchase price at $184,000 but vacated its determination that Troser had exercised its option to purchase Sullivan’s stock. Essentially, the court held that, while its 2010 decision had determined that Sullivan’s shares must be valued on the basis of his percentage interest in Troser’s assets, “issues of fact remain with respect to the appropriate method of valuing those assets.” The court amplified its ruling as follows:
Although plaintiff is not entitled to the “fair value” of the stock under Business Corporation Law § 1118 (b) because he does not own 20% of the outstanding shares and there is no evidence that defendant has engaged in “illegal, fraudulent or oppressive actions” toward plaintiff (§ 1104-a [a] ), it does not follow, as defendant suggests, that plaintiff is entitled only to book value. As the Court of Appeals has stated, “[t]here is no uniform rule for valuing stock in closely held corporations. One tailored to the particular case must be found, and that can be done only after a discriminating consideration of all information bearing upon an enlightened prediction of the future’ ” (Amodio v Amodio, 70 NY2d 5, 7, quoting Snyder’s Estate v United States, 285 F2d 857, 861).
We reject defendant’s related contention that the buy-sell agreement dictates that book value be used to determine the purchase price of plaintiff’s shares. As plaintiff notes, the buy-sell agreement provides that, if the stockholders, i.e., plaintiff and [Troser], did not agree upon the value of the shares for a period of two years, the agreed upon value shall be adjusted by the increase or decrease in defendant’s book value since the date of the last agreed upon value. Here, as we held in Sullivan III, the parties never agreed upon the value of the shares, and we thus conclude that there was nothing to adjust and book value does not come into play. Because defendant is not entitled to summary judgment on the issue of valuation, it shall be for the court to determine the appropriate valuation method based on the evidence at trial.
The appellate court agreed with Troser, however, that the lower court erred in determining as a matter of law that it had exercised its option to purchase Sullivan’s shares at a price to be determined by the court in the future. The issue had been raised below, not by motion, but in a letter to the trial court from Sullivan’s counsel seeking “clarification”. The appellate court concluded that “an issue of this magnitude” ought not to be determined “in the absence of a motion for summary judgment or a trial,” and it noted evidence in the record that Troser’s past offers to purchase Sullivan’s shares were conditioned on Sullivan selling his shares at a price acceptable to Troser.
You’ve got to figure that after ten years of litigation, including four appeals, likely the parties collectively have spent far more in legal fees than Sullivan’s shares are worth. On top of that, the litigants have yet to establish through their prodigious litigation efforts either (1) a methodology for establishing the value of Sullivan’s shares and (2) any certainty as to the exercise of Troser’s option to purchase Sullivan’s shares.
And to think, all of this could have been avoided had the parties prepared a simple schedule or certificate of value as contemplated by the 1986 buy-sell agreement. But do not view this omission as a freak occurrence. Rather, it is symtomatic of the myriad problems afflicting fixed-price buy-sell agreements.