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July 24, 2012
In Part I of the blog entry on the Link family food empire dispute, I discussed business litigation issues regarding the family members suing each other for breaching their fiduciary duties. However, Part II of our analysis addresses the fact that the dispute could likely have been avoided with a well-drafted contract among the family members – a contract commonly referred to as a buy-sell agreement.
A buy-sell agreement is a contract among co-business owners that sets out terms and conditions on which owners may, or must, sell their ownership, while similarly providing options or imposing obligations on the company or the remaining owners to purchase the ownership interest. Buy-sell agreements may be among shareholders in a corporation (shareholder agreement), members in a limited liability company (called an operating agreement) or partners in a partnership.
The Link family did have a shareholder agreement for the snack food empire, and I suspect they had to sell a lot of snacks to pay the legal fees for the contract. Unfortunately, like many standard buy-sell agreements we see, it failed to address the most significant points in resolving business disputes – it did not contain a clear, unambiguous trigger to force the sale by one party and the purchase by another in the event of a dispute, and it lacked a clear mechanism for determining the purchase price of the shareholder being forced to sell his or her shares.
To recap the family squabble, son Jay was forced out of the business by his father, Jack Link. Like many family businesses, the family members were not only investors but employees of the company. What often happens in these types of businesses is that the only job that family members have ever known is employment with the company, and therefore termination of that employment is not only a life changing event but it may also constitute oppression if owners gang up on a family member who owns a minority interest in the company.
There is often a misconception among business owners that they have an unfettered right to continued employment by virtue of the fact that they own a piece of the business. In fact, even 50% owners of a business may be terminated as an employee unless adequate protections are placed in the buy-sell agreement, in the written bylaws, or in other policies of the organization. For example, in a company with two 50% owners, one of the owners is often named the president and the other the vice president of the company. In the absence of a written agreement to the contrary, the president of the organization is typically authorized to hire and fire employees, meaning the president can fire the vice president even though the vice president owns 50% of the company.
The concept of “oppression” means that owners of the business are using legal or procedural means to unfairly squeeze out one of the other owners, and possibly force that owner to sell his or her ownership interest at a decreased value. That is one of the allegations that was made in theLink case.
The Link buy-sell agreement included a valuation of shares by having an appraiser determine the value. Jay complained that this valuation method was used to force him out and constituted oppression because Jay was forced to resell his shares to the corporation for less than he believed they were worth.
It is tough to feel too sorry for Jay in these circumstances, because he still received $19.4 million for his shares. The parties stipulated that the “fair value” of Jay’s shares was $31.8 million, which roughly corresponded to what Jay’s shares would have been worth if the entire company were valued or sold and he received his pro rata ownership share. However, Jay’s dad and brother decided to discount the price paid for Jay’s ownership because Jay’s shares could not be sold on the open market, and they represented a minority ownership of the corporation.
The minority and marketability discounts represent one of the drawbacks of many buy-sell agreements which rely on an appraisal method for setting a purchase price. Appraisers are typically certified public accountants, and they use a number of different tools in valuing assets. For ownership interests in businesses, CPAs often apply what are called marketability and minority discounts.
A marketability discount reflects the fact that the ownership interest is not available for purchase or sale in the open market, such as a stock exchange or over-the-counter. It is much more difficult to sell an ownership interest when there is not a marketplace to find willing buyers, so appraisers often impose a lower value.
It is also more difficult to sell a minority ownership interest in a closely-held company because the buyer will not have any control over the operations of the company. Consequently, appraisers often impose a minority discount. Both minority and marketability discounts can range around 20% each, meaning that if a shareholder is not properly protected he or she may end up accepting 60¢ on the dollar for the value of the ownership interest.
That is what happened to Jay in the Link case, leaving Jay to somehow have to find a way to live on $19.4 million. Although he sued for minority oppression and for dissolution of the corporation, the courts held that he could not sue because only shareholders are entitled to sue to enforce their rights with respect to a corporation. Because the buy-sell agreement at issue forced Jay to sell his shares in the corporation, he was no longer a shareholder and, thus, lost his ability to sue.
Concerns about discounts and being treated fairly should have been addressed in the buy-sell agreement at the beginning of the business venture (or at least addressed during the period in which the Links could still all attend family gatherings together without sitting with their backs against the wall). By thinking about these buy-sell agreement issues while everybody was getting along, they could have avoided the prolonged and expensive legal battles, not to mention preserved their future spots at the Thanksgiving table. And while it’s possible that Jay was being unreasonable and was not entitled to any more than the money he received, keep in mind that none of the shareholders know in the beginning whether they are going to be the one on the short end of the beef stick when the family food empire gets rotten. It could just as easily have been Jack or another sibling who was ousted, and then that person would’ve been forced to swallow a substantial discount on the business he or she helped build.
It would be nice if every business dispute left even the losing party with a consolation price of over $19 million, but unfortunately that is a rare exception. Make sure you have a well-drafted, unambiguous buy-sell agreement in place at the time you are forming your empire, food or otherwise, or when it comes time to split up the morsels you may simply end up with a few crumbs.
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