The title of this post should come as no surprise to those who follow Delaware corporate law. Unlike New York and the vast majority of other states, Delaware has no statute authorizing an oppressed minority shareholder to petition for judicial dissolution or to compel a buy-out. In its 1993 ruling in Nixon v Blackwell, the Delaware Supreme Court broadly rejected the notion that “there should be any special, judicially-created rules to ‘protect’ minority stockholders of closely-held Delaware corporations” (626 A.2d 1366, 1379). As the court explained, any right to be bought out is a matter of contract, not common law:
The tools of good corporate practice are designed to give a purchasing minority stockholder the opportunity to bargain for protection before parting with consideration. It would do violence to normal corporate practice and our corporation law to fashion an ad hoc ruling which would result in a court-imposed stockholder buy-out for which the parties had not contracted.
Trapped-in minority shareholders in Delaware close corporations who fail to perfect contractual buy-out rights in their shareholder agreements have been forced to pursue alternative theories of relief — and none too successfully. The Delaware Supreme Court, in a decision issued last week in Blaustein v Lord Baltimore Capital Corp., No. 272 [Del. Sup. Ct. Jan. 21, 2014], threw cold water on two alternative theories used by a frustrated minority shareholder whose shareholder agreement permitted but did not require the company to repurchase shares subject to specified levels of board or shareholder consent.
Blaustein is an appeal from a ruling dismissing the suit by Vice Chancellor Noble of the Delaware Court of Chancery, which I wrote about here. In a nutshell, the plaintiff Blaustein owns about 17% of the voting shares of an S corporation known as Lord Baltimore Capital Corp. (LBCC) formed in 1999 as part of a reorganization and split-up of a predecessor C corporation. The controlling interest in LBCC is held by Louis Thalheimer and his family members. Blaustein alleged that she invested in LBCC based on Thalheimer’s oral promise to repurchase her shares at their full pro rata book value after 10 years. 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 only buy-out right in Section 7(d) of the agreement provides that LBCC “may repurchase Shares upon such terms and conditions agreeable to the Company and the Shareholder who owns the Shares” conditioned on approval by a majority of the board or 70% of the shareholders.
The 10-year waiting period expired, after which Blaustein demanded that LBCC repurchase her shares at their full pro rata value. Thalheimmer rebuffed the demand and countered with an offer that applied a 52% discount which Blaustein considered “punitive.” In her subsequent lawsuit, Blaustein claimed that Thalheimer and his hand-picked directors on the board were motivated by Thalheimer’s personal concern that a buy-out of Blaustein at full value would undermine stock valuation discounts taken in gift tax returns for shares that had been gifted to members of the Thalheimer family.
Vice Chancellor Noble’s decision last year granted summary judgment dismissing Blaustein’s action. Her subsequent appeal to the Delaware Supreme Court asserted two legal theories supporting a claim for a repurchase of her shares: first, that “non-conflicted” directors have a common-law fiduciary duty to consider buying out minority shareholders and, second, that the implied covenant of good faith and fair dealing created a duty to negotiate a reasonable purchase price for her shares under Section 7(d) of the LBCC shareholders’ agreement.
The Supreme Court, in a 12-page decision by Justice Carolyn Berger, made short work of Blaustein’s two theories. The opinion dispatches Blaustein’s fiduciary duty claim in a single paragraph, as follows:
Under common law, the directors of a closely held corporation have no general fiduciary duty to repurchase the stock of a minority stockholder. An investor must rely on contractual protections if liquidity is a matter of concern. Blaustein has no inherent right to sell her stock to the company at “full value,” or any other price. It follows that she has no right to insist on the formation of an independent board committee to negotiate with her. [Footnotes omitted]
In the omitted footnotes, the opinion cites the above-mentioned Nixon v Blackwell and Supreme Court’s 2010 decision in Nemec v Schrader in which it rejected a claim that directors of Booz Allen breached fiduciary duty by exercising redemption rights under an officers stock plan to redeem the shares of retired officers at a lower price in anticipation of a lucrative merger with the Carlyle Group.
Justice Berger devotes only slightly more space to rejecting Blaustein’s second theory, to wit, that Section 7(d) of the shareholders’ agreement contains an implied contractual right to good-faith negotiation of stockholder redemption proposals. Here’s what Justice Berger writes:
[T]he plain language of Paragraph 7(d) gives both parties complete discretion in deciding whether, and at what price, to execute a redemption transaction. Paragraph 7(d) states that “the Company may repurchase Shares upon terms and conditions agreeable to the Company and the Shareholder who owns the Shares to be repurchased . . . .” This provision is permissive. The remainder of Paragraph 7(d) requires that any repurchase be approved by a majority of the directors or 70% of the stockholders. The approval requirement protects [LBCC] and the non-selling stockholders from a stock repurchase that is not in their best interest.
The implied covenant of good faith and fair dealing cannot be employed to impose new contract terms that could have been bargained for but were not. Rather, the implied covenant is used in limited circumstances to include “what the parties would have agreed to themselves had they considered the issue in their original bargaining positions at the time of contracting.” Here, the parties did consider whether, and on what terms, minority stockholders would be able to have their stock repurchased. Paragraph 7(d) does not contain any promise of a “full value” price or independent negotiators. [Footnotes omitted; quoting Gerber v Enterprise Products Holdings, Inc., 67 A.3d 400, 418 (Del. 2013)].
In a comment to my prior post on Chancery Court’s decision in Blaustein, leading Delaware corporate lawyer Vern Proctor advised that potential non-controlling investors in Delaware entities “should approach such opportunities with their eyes wide open and a good set of lawyers who will negotiate aggressively on their behalf.” Amen.