This post is part of a series of posts related to Minnesota minority shareholder rights. The following posts cover specific issues related to minority shareholder rights:
- Introduction to minority shareholder rights
- Employment issues
- Accessing Corporate records
- Corporate Governance
As a practical matter, closely-held corporations rarely pay dividends. The Supreme Court of Minnesota recently re-confirmed in, U.S. Bank N.A. v. Cold Spring Granite Co., 802 N.W.2d 363, 378 (Minn. 2011), that one of the characteristics of a closely held corporation is lack of dividends. Probably the strongest driver behind that decision arises out of double taxation that corporate dividends are normally subject to. However, when a shareholder invests funds in a corporation, some form of income is expected, especially when the corporation is profitable. More often than not, the income is received in form of salary or further shares of stock.
In Gunderson the court confirmed the existence of this arrangement when it mentioned that one of the expectations a shareholder likely has after investing in a closely-held corporation is to receive a “salary and benefits constitute[ing] de facto dividends” Gunderson, 628 N.W.2d at 191. Another possible source of income in lieu of dividends is the buy-back agreement. When shareholders invest their funds, the stock certificates or their equivalents can contain such an agreement. Normally, the buy-back agreement requires the corporation to purchase all of the shareholder’s shares at conclusion of employment with the corporation.
Having a buy-back agreement can lead to an issue in the future unless it is drafted correctly. Prime challenge with following through with one of these agreements is how does one value the stock, years after the formation of the corporation? An interesting example of the magnitude of this difficulty was brought to light in Berreman v. West Publishing Company, 615 N.W.2d 363 (Minn. Ct. App. 2000).
Berreman was with West Publishing for some 25 years prior to informing the CFO of his intention to retire. Id. at 365. As a high level manager, Berreman exercised his option to buy 1,600 shares of company’s stock at a time past. Id. The stock purchase agreement granted West the option to buy the stock back from Berreman if he ever decided to sell it at book value. Id. at 365-66. West exercised the option the day after Berreman retired and paid $2,088.90/ share. Id. at 366.
About a week before Berreman’s retirement, the Board of the company met to discuss the possibility of West being acquired by A.G. Edwards. Id. Berreman was not made privy to that information prior to his stock being repurchased by West. About a year after Berreman’s retirement, West merged with Thomson Company and the West shares were bought by Thompson for $10,455/share. Id. at 367.
The claims brought by Berreman included failure to disclose material information due to the presence of the fiduciary duty between shareholders in a closely-held corporation. Id. The fiduciary duty issue will be discussed in a later section. For the purposes of the topic discussed in this section, only the $8,366.10/share price difference is significant.
The events encountered by Berreman are not likely to be repeated often. The huge discrepancy between the book value established at time Berreman sold his shares, and the value agreed upon in the merger can, and likely is explained by the premium shares receive in a well-managed bidding contest for a valuable target of an acquisition. However, that does not diminish the significance the issues shareholders face when trying to value their shares, at the time corporation exercises a buy-back provision, or the shares are re-acquired for some other reason.
The greatest dividend that every shareholder of a closely-held corporation should expect is the recouping of the initial investment in the corporation, plus the fruits of the time and labor dedicated to the strengthening of the corporation, evidenced by increase in the value of the stock. If however, at the time of acquiring the stock, a way to evaluate the growth in the value of the company in the future is not agreed upon, the likelihood of that occurring is slim, at best. Therefore, one of the key things to remember, when considering acquiring shares of any closely-held corporation is to be aware of how the changes in the value of the shares are determined.
As will be discussed in greater detail in the remedies section, if shareholders do not agree on a process for evaluating shares in the future, the courts of Minnesota have been authorized by the legislature to identify a value “fair and equitable to all parties.” Advanced Communication Design, Inc. v. Follett, 615 N.W.2d 285, 290 (Minn. 2000).