Buy-Back Agreements: Removing a San Diego Shareholder for Cause or No-Cause

With small, closely-held San Diego corporations and limited liability companies, it is important that the shareholders, members, and owners get along at a basic level. Maybe not best of friends, but the ability to work together for the betterment of the business is essential. Such is obviously less important with large corporations with many shareholders. With companies of that size, the issue of “getting along” becomes more important for the board of directors. In any event, a corporation occasionally finds itself with a shareholder or owner who is NOT, in fact, acting to the betterment of the business and needs to be removed as an owner. This is the purpose of a Buy-Back Agreement. These are similar to Buy-Sell Agreements except that the buying-back of the ownership shares/interests is compulsory rather than mutually agreed-upon.

Buy-back provisions can, of course, be incorporated into a standard Buy-Sell Agreement. Legal issues are complicated if the shareholder/member is also an employee and a member of the board or is one of the managers of your LLC. You should consult a good San Diego business lawyer if you need a buy-back agreement drafted or if you find your business needs to remove an owner. Here is a quick discussion.

San Diego Corporate Law: Valuation is the Contentious Issue

As with a standard Buy-Sell Agreement, the key component of a Buy-Back Agreement is how to value the ownership shares/interests. The procedure is usually straightforward — the other owners vote to remove the errant owner. That is, the other owners vote to trigger the provisions of the Buy-Back Agreement.

As noted, the Buy-Back Agreement can be structured so that no cause need be established for removal. This would be similar to the idea of “at-will” employment, and similar legal principles with respect to public policy would apply. If the Agreement requires some cause, then the agreement must contain mechanisms for bringing the “for-cause” justifications to the owners, procedures for investigating the “for-cause” and for providing the target with an opportunity to respond or present a defense and more. Various “for-cause” reasons might include:

• Discrimination and racism
• Harassment
• Violation of laws
• Theft or other crimes
• Corporate waste and taking of corporate opportunities
• And more

As noted, the most contentious issue is valuation, and this is the most commonly litigated aspect of any buy-back or buy-sell agreement. The target errant owner essentially claims that the corporation and other owners did not pay the fair market value for the shares/ownership interest. Thus, it is important to establish in the Buy-Back Agreement a mechanism for valuation and dispute resolution. Make no mistake: removing an owner will take some time and will cause a lot of strife. Among the mechanisms that should be agreed to up front, include who will prepare the valuation or how that person/firm will be chosen. Valuations are expensive, so the agreement should specify who pays for the valuation. Often, the company pays for the original valuation and the target/errant owner must pay for any competing valuation. To avoid litigation, a dispute resolution mechanism must be chosen such as mediation by persons pre-chosen or binding arbitration.

San Diego Corporate Law: When You Cannot Force a Buy-Back

Under California law, controlling shareholders owe fiduciary duties to minority shareholders/owners. Among these duties are the duty of fairness and the duty to not self-deal. Thus, as an example, owners having a 75% combined percentage ownership of the company cannot treat the owners of the other 25% unfairly and/or obtain greater benefits for themselves. Therefore, it would be “minority shareholder oppression” to force a buy-back of certain shares at $100 per unit and then, several months later, sell all the shares of the company for $200 per ownership unit including the shares bought at $100 per unit. Such behavior will bring a quick lawsuit by the forced-out owner(s) and, likely, a quick victory for them. This is particularly true if the offer at $200 per ownership unit was known before the Buy-Back Agreement was triggered.

Contact San Diego Corporate Law

For further information, please contact Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard has been named a “Rising Star” four years running by SuperLawyers.com and “Best of the Bar” by the San Diego Business Journal. Contact Mr. Leonard via email or by calling (858) 483-9200.

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