Finkel Law Group recently represented several shareholders of a privately held commodities trading firm in a contentious buy out of departing shareholders who demanded several million dollars for their stake in the company. As a result of the firm’s efforts, the departing shareholders ended up with one-third of their original demand.
A critical factor in the firm’s success negotiating a favorable resolution of the matter was its ability to credibly threaten enforcement of the valuation provisions in the shareholder agreement to force mediation. When forced to confront the actual value of the company and the looming costs of litigation, the departing shareholders quickly settled for a fraction of their original asking price.
In July 2012, a small group of the corporation’s shareholders provided notice to the company that they wished to sell their shares in the corporation. They demanded more than $3.6 million for their interest. The company demurred, and asked for financial evidence substantiating the demand. The departing shareholders ignored the request, and instead quickly reduced their demand to $2.2 million. The company demurred yet again, recognizing the departing shareholders’ tactics as nothing more than an effort to extort money from them. In an attempt to negotiate a resolution of the dispute, the remaining shareholders asked the departing shareholders to participate in a meeting to agree on a valuation of the company based on actual financial data, as contemplated in the company’s shareholders agreement, rather than wishful thinking.
The departing shareholders refused. Instead of reasonably resolving the dispute by conducting a valuation, they filed suit against the remaining shareholders, and the company, seeking damages for waste of corporate assets and an order allowing them to inspect the corporate books and records. The departing shareholders hoped to prove the remaining shareholders had engaged in various acts or misfeasance and malfeasance. The remaining shareholders filed a cross-complaint, seeking damages for breach of fiduciary duty and an injunction enforcing the buy out provisions in the contract.
In the weeks leading up to the litigation, the remaining shareholders conducted a valuation of the company showing it was worth less than $3 million, far less than the $4.4 million dollar price tag the departing shareholders hoped for. It quickly became clear the departing shareholders wanted to avoid an accurate valuation of the company and simply extort money from the remaining shareholders.
After three failed attempts, the departing shareholders secured a court order instructing the company to produce corporate books and records. As the old saying goes, “be careful what you wish for . . . because you may actually get it.” As a result of the court’s order, the departing shareholders found themselves in the position of having to review thousands of pages of documents, and conduct a forensic accounting of the company’s financial statements to show them what they already knew: The remaining shareholders had not wasted corporate assets and the company was not worth anywhere near $4.4 million. After their ill-conceived strategy backfired, the departing shareholders quickly reached a settlement of the pending lawsuits that resulted in a payment of just over $1 million for their stake in the company, far below the $3.6 million originally demanded.
There are several take aways from this case.
First, it is critical to have a well-prepared contract in place so you can enforce your contractual rights against a departing shareholder or partner bent on extorting money from you.
Second, make sure the contract contains clear, concise and understandable provisions, particularly with respect to the provisions dealing with the valuation and buy out of departing shareholders’ stock. Ambiguity only foments argument and increases your costs when negotiating a buy out.
Third, make sure your attorney works closely with the company’s officers to gather all the relevant facts so you can forcefully and credibly confront the demands of dishonest shareholders bent on extorting money from the company to enrich themselves at the expense of the remaining shareholder. Cold, hard facts defeat bluster and bravado every time.