Family-owned business shareholders often enter into buy-sell agreements that provide the terms on which an owner can or must sell his or her shares. Such agreements usually restrict an owner’s ability to sell shares to third parties without first offering them to the company or other shareholders. Rights of offer are also often specifically triggered upon a shareholder’s death. Finally, these agreements typically spell out the timing and source of the payment by the purchasing company or shareholder.
In a family business context, transfers of shares by or between owners can have effects that last for generations. Thus, it is important that the buy-sell agreement clearly identify the types of proposed transfers that are subject to restrictions. By doing so, the owners can fully understand their current and future economic and share voting rights, as well as how a potential transfer of another shareholder’s stock could affect those rights.
A recent case from Florida – Hollinger v. Hollinger (Fla. Dist. Ct. App. Mar. 20, 2020) – highlights certain issues that can arise when the terms of a buy-sell agreement are unclear. According to the Court’s decision, brothers John and Michael Hollinger each owned 49% of the shares of Rex Engineering Corporation, a gear and valve manufacturer. Their father, who had founded the company, owned the remaining 2% of the company’s shares.
In order to “promote the successful and harmonious ownership and management of the corporation,” the brothers and their father had executed a buy-sell agreement setting forth certain restrictions regarding the transfer of the company’s stock. The agreement contained a provision that required a shareholder who wished to dispose of his shares during his lifetime to first offer to sell the shares to the corporation. The agreement also specified the purchase price and terms for such a sale. If the corporation did not accept the offer to purchase, the stock could be disposed at a purchase price no more favorable than the price offered to the corporation. Finally, the agreement provided that upon a shareholder’s death, his shares would be sold to the corporation.
Conflict developed between Michael and John and their father. After Michael’s wife was fired from her job at the company, Michael sued John and their father, alleging breach of fiduciary duty, conversion and other claims. After filing suit, Michael’s employment with the company was terminated. The father thereafter signed his stock certificate for 2% of the company’ shares and delivered it to John. The father passed away approximately two months later. Michael then amended his complaint to also allege that the father’s transfer of his shares to John was void because he did not first offer to sell the shares to the corporation under the agreement. Michael further claimed that John still owned only 49% of the shares and that the father’s shares must be sold to the corporation following his death.
In response to Michael’s claims, John asserted that the father’s transfer of his shares to John was a gift and not a sale and therefore the agreement’s restrictions did not apply. For his part, Michael argued that the agreement applied to transfers by gift as well as by sale. In ruling on Michael’s summary judgment motion, the trial court decided that the agreement unambiguously applied to “any disposition of the stock, including gifts.” Thus, the trial court concluded that the father’s “attempted transfer” of his shares to John failed because he did not first offer to sell the shares to the company.
On appeal, the Appeals Court decided that the trial court should not have allowed Michael’s summary judgment motion because there was “latent ambiguity” in the agreement. While the terms of the agreement were clear on their face, the circumstances of the transfer revealed “an insufficiency in the contract of a failure to specify the rights or duties of the parties in certain situations.” Specifically, the Appeals Court determined that the agreement’s terms did not clearly apply to a gift of stock. Instead, the language of the agreement set forth the procedure for offering the shares to the corporation “for purchase” and, if the corporation did not “purchase” the shares, the shareholder could then dispose of the shares as he saw fit, except for the continuing restriction that the “purchase price” would be no less than the “price for which the corporation could have purchased the stock.” According to the Appeals Court, “because the transfer was a gift to [John] from his father and not a ‘purchase,’ there would have been no ‘purchase price,’ and the agreement is unclear or ambiguous as to how, what or whether [John] would have had to pay anything or how the father could consummate this gift” to John.
Because of the ambiguity in the agreement as applied to the proposed transfer at issue, the Appeals Court determined that further proceedings were required to determine whether the parties understood or intended the agreement to apply to the attempted transfer by gift at issue in this case. The Court thus reversed the summary judgment order and remanded the case to the trial court. While it is unclear what will happen on remand, the parties’ dispute is all but certain to become more time-consuming and expensive due to the Court’s determination that the agreement was ambiguous as to what types of transfers it covered.
The Hollinger case serves as a reminder that family business owners should carefully draft their buy-sell agreements to reflect their intentions and understandings as to what types of transfers will be governed.
In particular, if the parties want to exclude gifts of shares from the scope of a buy-sell process, they should specifically exclude gifts from the definition of “transfer.” If the parties instead want to include gifts within the scope of restricted transfers, they should say so explicitly and should also ensure that the remaining terms do not create ambiguity as to how a transfer by gift would be treated under the agreement. In either case, parties will want to be clear as to whether a particular transfer will be subject to the agreement’s restrictions. By doing so, they may be better able to avoid lengthy, disruptive and costly disputes over the scope and effect of an agreement’s potentially ambiguous terms.