Texas Business Dispute Blog

Friday, March 28, 2014

The Iron Clad Buy-Sell Agreement Cracks Have Developed in Texas Law

By Ladd Hirsch

Until recently, Texas courts routinely gave the trump card to majority owners of private companies in conflicts with minority investors when they had entered into a buy-sell agreement.  Specifically, if the minority investor entered into a buy-sell agreement, the investor was bound to the buy-out formula in the agreement despite any later actions by the majority that were allegedly to be improper. This settled rule has been modified, however, by recent Texas appellate cases.  Indeed, unless the Supreme Court intervenes, minority investors have the right to challenge the enforcement of a buy-sell agreement when the majority owners engage in conduct that deprives the minority investor of the benefit of its bargain.

In July 2012, the Dallas Court of Appeals declined to enforce a buy-sell agree-ment at the majority shareholder’s request based on jury findings that the majority owner had oppressed the minority shareholder. The appellate court upheld the jury verdict and awarded the minority investor a buyout at “fair value” rather than “book value” provided by the buy-sell agreement. See Cardiac Perfusion Servs., Inc. v. Hughes, 380 S.W.3d 198 (Tex. App.—Dallas 2012, pet. filed)(Supreme Court requested briefs on the merits in June 2013, but has not yet formally granted or denied petition for review)

The dispute in Cardiac arose out of the majority owner’s decision to fire his employee and redeem his minority (10%) interest for a heavily discounted book value in reliance on a buy-sell agreement.  From 1991 to 2006, the two owners grew their medical practice into a profitable company. Along the way, however, the majority owner took out significant cash for himself and his family.  Promptly after firing the minority investor, the majority owner filed claims against him to trigger the buy-sell agreement enabling him to purchase the investor’s stock for its discounted book value.

The minority owner filed counterclaims and alleged that the majority owner had oppressed him as the minority shareholder and had used the company “to pursue [his] self-interests” or for “his own personal gain.” The majority owner also refused to turn over company books and records for review by the minority owner.  At trial, the minority owner presented evidence and expert testimony that the majority owner had engaged in a number of improper actions, including: (a) having the company pay more than $325,000 to the majority owner’s college-age children as “salary” for meaningless work; (b) paying himself grossly excessive compensation of $775,000 per year when compensation data for peer companies show a reasonable salary was less than $275,000; and (c) seeking reimbursement from the company of more than $64,000 in credit card bills that were not legitimate business expenses.

The jury found that the majority owner had: (a) suppressed profit distributions; (b) paid himself excessive compensation; (c) made improper payments to his family members; (d) improperly paid personal expenses from company funds; (e) wrongfully exploited his control of the company to lower the overall value of the minority owner’s stock; and (f) failed to permit the minority owner to examine and make copies of the company’s books and records.

The majority owner contended at trial that the minority investor was entitled to book value for his minority interest of $77,674 based on the buy-sell agreement, but the jury found and the trial court upheld the finding that the value of the minority investor’s 10% interest was $300,000.  Throughout the majority owner’s appeal and to the Texas Supreme Court, his primary argument is that the buyout should be limited to $77,674 (book value) because the buy-sell agreement trumps the minority owner’s oppression claims and courts should not “rewrite” the contract to allow for a different valuation.

The holding in Cardiac rejecting the rule of rigid adherence to the terms of a buy-sell agreement was followed last year by the El Paso Court of Appeals.  See Kohannim v. Katoli, No. 08-11-00155, 2013 WL 3943078, at **12-13 (Tex. App.—El Paso July 24, 2013, pet. denied) (citing Cardiac Perfusion Servs., Inc. v. Hughes, 380 S.W.3d 198, 203 (Tex. App.—Dallas 2012, pet. filed). 

Based on the trial court’s findings that the majority owner had engaged in oppressive conduct, the Kohannim appellate court declined to enforce the provisions of an LLC operating agreement governing the method for valuing a minority interest in the business.  The appellate court affirmed the lower court’s decision to permit redemption of the minority owner’s interest for fair value, rather than fair market value, after concluding that “courts have equitable powers to fashion appropriate remedies where the majority shareholders have engaged in oppressive conduct.” Davis v. Sheerin, 754 S.W.2d 375, 380 (Tex. App.-Houston [1st Dist.] 1988, writ denied).


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