Hunt & Associates P.C.

When “Fair Value” is not Fair

The recent Oregon Court of Appeals case, Marker v. Marker, is a fine example of a case that could have had a different result with proper planning.  The facts are simple and common:  A father and son organized a trucking company in 1982.  Father owned 52 percent of the shares and Son owned 48 percent, meaning that Father essentially controlled the company.  Both are employees.  Over time, disputes arose between Father and Son and in 2006 Father fired Son.  Son continued as a shareholder but Father stopped sharing any corporation information with Son.  There is no indication that a buy-sell agreement between Father and Son existed.

Son sued Father alleging among other things that Father engaged in oppressive conduct.  The trial court found that Father’s behavior was oppressive and as a remedy ordered Father to purchase Son’s shares at their “fair value” – a term not to be confused with “fair market value”.

The court enlisted the services of an appraiser to determine the shares “fair value”.   The appraiser determined that the “fair market value” of Son’s 48 percent ownership interest was $78,000.00 after applying applicable discounts (minority ownership discounts and lack of marketability discounts).  However, the appraiser determined that under Oregon law, the “fair value” standard did not allow for discounts making the “fair value” of the shares $134,000.00.   The court ordered the company and Father to pay this amount within 20 days from the date of entry of the judgment.

The court of appeals did not dispute the valuation since ORS 60.952(a)(A) provided that the proper valuation formula for the court to use when it orders the sale of stock is the “fair value” formula without applying any discounts.  In Marker and in the case of most small companies the difference between fair value and fair market value is great and a compelled sale of the stock at “fair value” could potentially cripple, if not destroy, a small business.  Consequently, most companies would like to avoid these results if at all possible.

The use of a buy-sell agreement (also known as a restrictive stock agreement) is one way that shareholders can limit the application of ORS 60.952 and its potentially crippling results.  ORS 60.952(3) provides that the remedies provided in ORS 60.952 can be limited by an agreement entered into by the shareholders.  Consequently shareholders can agree to a valuation formula different from the “fair value” formula and can also limit the circumstances in which a court can force the sale of stock.  It can also provide circumstances that require the sale of stock, but provide for the proper valuation of that stock.

A buy-sell agreement is an agreement between shareholders that controls a shareholder’s ability to voluntarily and involuntarily transfer shares of stock in the company and provides for circumstances that, if they occur, would compel the Company or shareholders to purchase another shareholders’ shares of stock.  It can limit a shareholder’s ability to sell or gift shares and can compel the sale of shares when a shareholder dies, retires, gets divorced, files bankruptcy or has their employment terminated.

The agreement also provides a valuation formula which may be different depending on the event that occurs that compels the sale of stock.   For example, the agreement can provide that upon a shareholder’s death, the deceased shareholder’s estate must sell any shares owned by the deceased shareholder to the company or the living shareholders.  The value can be the fair market value of the shares at the time of death, their fair value, or their book value.  The shareholders can determine whether discounts or premiums should be applied in determining value.   Whether these discounts or premiums should be applied may depend on the circumstances.  The shareholders may want a discount to apply upon a shareholder being fired but not when a shareholder dies or retires.

In the case of the Marker shareholders, they could have agreed that upon an employee’s termination, the company or remaining shareholders were required to purchase the terminated shareholder’s shares at the share’s fair market value.   By forcing the employee to sell his shares to the company or remaining shareholder, the company ensures that a disgruntled and disinterested shareholder is not involved with the company.  If they agreed that the proper valuation formula was the fair market value with applicable discounts, the company and father would have saved over $50,000.00 (not including attorney fees and costs incurred in the litigation).

An additional benefit of a properly drafted buy-sell agreement is that the agreement provides for an installment payment plan that allows the company and remaining shareholders to pay the ex-shareholder over time (such as a 10 percent down payment with the balance payable in monthly installments over the next 10 years).  As a business owner, imagine having 20 days to produce $134,000.00 to pay your son.

In order to avoid the crippling results of Marker and ORS 60.952, companies with more than one shareholder need to have a buy-sell agreement in place. If you have an existing business and you do not have a buy-sell agreement, it’s not too late to enter into a buy-sell agreement.   Such an agreement can be entered into by the shareholders at any time.

©11/04/2010 Kevin J. Tillson of Hunt & Associates, PC

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