“Under any standard of value, the true economic value of a business enterprise will equal the company’s accounting book value only by coincidence . . .” says the late business valuation expert and author Shannon Pratt.  So why do so many shareholder buy-sell agreements require that the shares be purchased for book value? 

While I can think of a few likely answers to that question (e.g., ease of calculation, agreements modeled on BCL 1510, and the likelihood that for operating businesses fair value will exceed book value), the near certainty of a disparity between book value and fair value increases the odds for litigation.  Inevitably, one party to a book value buy-sell agreement is getting a bad deal. 

As a result, New York caselaw is filled with cases covering all sorts of attempts to evade the sometimes economically harsh consequences of a book value buyout, to varying degrees of success.  Neville, Rodie and Shaw, Inc. v LeGard, 3:23-CV-266 (D Conn Feb. 16, 2024) is the latest.

Courts Lean Toward Enforcement of Book Value Buy-Sell Agreements

Challenges to the enforcement of a book value buy-sell agreement in New York caselaw are plentiful; successful ones are scarce. Notable cases considering—and often rejecting—a shareholder’s bid to avoid the enforceability (and therefore, the economic repercussions) of a book value buy-sell agreement include:

  • Stern v Birnbaum, where the Second Department affirmed a trial court’s order enforcing a shareholders’ agreement that granted the survivor an option to purchase the decedents shares of a closely held corporation at one-half of the book value, as determined by the corporation’s accountant (206 AD2d 514, 515 [2d Dept 1994]).
  • Rosiny v Schmidt, where the First Department reversed the trial court’s finding that a mandatory book value buyout provision was unconscionable (185 AD2d 727 [1st Dept 1992]).
  • Matter of Tatko v Tatko Bros. Slate Co., Inc., where the Third Department addressed competing methods for calculating book value, observing that “book value” was “[a]n imprecise term at best” (173 AD2d 917, 917 [3d Dept 1991]).

If there’s a lesson to be learned from New York’s body of caselaw concerning book value buyouts, it’s that a disparity between the book value and fair value alone will not invalidate a provision requiring a book value buyout.  Perhaps that principle is best embodied in the First Department’s decision in Johnsen v ACP Distrib., Inc., which enforced a buy-sell provision fixing the share price at only 70% of book value (31 AD3d 172, 175 [1st Dept 2006]).  On the other hand, an ambiguity in the agreement or a bona fide dispute over how book value should be calculated stands a far better chance at succeeding.  

The Neville, Rodie and Shaw Buy-Sell Agreement

Neville, Roadie and Shaw, Inc. (“NRS”) is a New York City-based investment advisory firm.  Throughout the Corporation’s 90-year history, its shareholders have always been professionals at the firm.  This dispute centers on the shares held by the estate of Edwin LeGard, a former investment manager who at the time of his passing owned 20 of NRL’s outstanding shares.

NRS’s shares are subject to a shareholders’ agreement governed by New York law.  And, consistent with the Corporation’s history of only its professionals being shareholders, the shareholders’ agreement contains both transfer restrictions and a post-mortem buyback provision.  The latter requires the Corporation to repurchase the shares held by any deceased shareholder at book value:

Upon the death of any Shareholder, the Corporation shall have the obligation to purchase all of the decedent’s shares as soon thereafter as is practicable. The purchase price shall be the Book Value of the shares as of the end of the fiscal year completed prior to the date of the shareholder’s death after the audit for such year has been finalized.

So far, so good.  I’ve seen many buy-sell provisions just like this one.  In the next paragraph, things get slightly more interesting.

If a deceased shareholder’s shares are not purchased by the Corporation (or the other Shareholders) within one year from the date of death, the legal representatives and/or beneficiaries or heirs shall have the right to sell such shares, but the Corporation’s obligation to purchase such shares shall continue in effect until such shares are sold, at which time its obligation shall expire without liability of any kind to the Corporation.

So, despite obliging the Corporation to repurchase a deceased shareholder’s shares, the shareholders’ agreement goes on to contemplate a circumstance where the shares are not repurchased.

The Book Value Calculation

When LeGard passed away in September 2022, the Corporation calculated the per share book value for the year ending in 2021, and it provided LeGard’s estate with the financial information supporting that calculation.  The Estate refused the Corporation’s demand that the Estate sell LeGard’s shares back to the Corporation at their book value, approximately $15,000 per share.

LeGard’s Attempt to Evade the Book Value Buyback

LeGard’s Estate pinned its refusal to sell its shares on a creative interpretation of the interplay between the two above-quoted paragraphs.  The Estate argued that although the shareholders’ agreement provides that the Corporation has an obligation to purchase the decedent’s shares at book value, the shareholders’ agreement does not impose on the Estate an obligation to sell them at book value.  To the contrary, argued the Estate, the shareholders’ agreement expressly leaves open the possibility that the Estate may reject the offer. 

Why else, argued the Estate, would the shareholders’ agreement go on to explain what happens if the Corporation did not close on the book value sale? That provision must mean that the Estate has the right to reject the Corporation’s book value offer.

The Decision

The Court disagreed.  By opinion and order dated February 16, 2024, Connecticut Federal Judge Victor A. Bolden granted judgment in favor of the Corporation on its claim to repurchase LeGard’s shares at book value.

Judge Bolden held that the Estate’s interpretation of the shareholders’ agreement—i.e., that it only obliges the Corporation to purchase, not the Estate to sell—collapsed under the weight of the transfer restrictions in the shareholders’ agreement. 

The Court held that the whole purpose of the transfer restrictions set forth in the shareholders’ agreement is to limit the class of potential shareholders—a limitation that has existed since the Corporation’s founding.  So interpreting the shareholders’ agreement in a way that gives LeGard’s Estate the option to retain (and ultimately, transfer) his shares would vitiate the purpose of those transfer restrictions:

In short, the general purpose of Section 2 of the Agreement is to limit the transfer rights of shareholders, in order to prevent the free transfer of stock. It would be contrary to the principles of contract interpretation for this Court to read in an implied right of a Decedent’s estate to retain or sell the Decedent’s stock.”

Relying on a decision in a case litigated by yours truly, Estate of Collins v Tabs Motors, (discussed here), Judge Bolden concluded that “New York courts regularly grant specific performance as a means of enforcing buy-sell provisions,” and entered an order requiring the Estate to sell its shares to the Corporation for book value.

Closing Thoughts

On the surface, Neville reinforces the unremarkable proposition that a too-cute interpretation of a shareholders’ agreement’s buy-sell provision likely will yield to courts’ general tendency to strictly construe transfer restrictions and to enforce buy-sell agreements as written.  But it also serves as a fine springboard for a few more nuanced observations:  

Back to basics on offer, acceptance, and options.  Though not cited by either the parties or the Court, I think the Second Department’s decision in Claire v Wigdor lends a fresh perspective (24 AD2d 992, 993 [2d Dept 1965]).  That court held that similar language gave the corporation an “option,” to repurchase the decedents shares, and its transmission of the book value calculation to the decedent-shareholder’s estate was “acceptance by an optionee,” not an “offer” that could be rejected.  With these contract basics in mind, the outcome in Neville seems obvious, especially for those familiar with this post on Walsh v. White House Post Productions, LLC, C.A. No. 2019-0419-KSJM [Del Ch Mar. 25, 2020].

The “elements” of book value.  In 1955, the Court of Appeals declined to announce a particularized definition of the term “book value,” but it did offer two necessary elements: “(1) the book entries must be correct and complete, and not made to defeat an outstanding claim, and (2) accepted accounting principles should not be entirely disregarded” (Aron v Gillman, 309 NY 157, 160 [1955]).  Those considering a book value buyout should ensure fidelity to those elements.

Remember Piekos; the event triggering the buy-sell provision can be critical.  In Neville, the Court specifically enforced a book value buy-sell provision triggered by the death of the shareholder.  But who can forget former Justice Scheinkman’s decision In re Piekos (discussed here), which left considerable room for debate about whether an oppression-based dissolution petition under BCL 1104-a could serve as a trigger for a contractual buy-sell agreement at a deeply discounted price (28 Misc 3d 1220(A) [Sup Ct 2010]).