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Trepanier MacGillis Battina P.A. 8000 Flour Exchange Building 310 Fourth Avenue South Minneapolis, MN 55415 612.455.0500

Breaking the Bank for a Minority Shareholder Buyout

In Lewis v. Borchert, A14-0379, 2015 WL 133992 (Minn. Ct. App. Jan. 12, 2015), the Minnesota Court of Appeals affirmed a Le Sueur County District Court ruling that two shareholders acted in bad faith when they refused to buy out a minority shareholder’s interest in one company unless he agreed to sell his interest in another related company for substantially less than the terms of a mutually-agreed upon buy-sell agreement. The Minnesota Court of Appeals also affirmed the district court’s holding that the valuation of a minority shareholder’s interest in a corporation is based on the pro rata value of the corporation as a going concern and should not be adjusted for a “lack-of-control” or “marketability discount,” absent extenuating circumstances. The court’s ruling provides guidance on the rights of minority shareholders to force buyouts where they are unduly prejudiced by the conduct of their co-owners.

In Lewis, Timothy E. Lewis (“Lewis“), Paul Borchert (“Borchert“), and Jeffrey McDonald (“McDonald“) were partners in two related businesses: BLM Properties (“BLM“), a real-estate holding company, and Canopy, an insurance company that operated out of a building owned by BLM. Lewis, Borchert, and McDonald each owned a 1/3 interest in BLM, but Canopy’s ownership was divided 30% (Lewis), 36% (Borchert), and 34% (McDonald).

In late 2011, the working relationship between Lewis and Borchert deteriorated to the point where the parties could no longer work together. Sometime thereafter, the parties began negotiating a transaction in which Borchert and McDonald (collectively, “Appellants”) would buy out Lewis’ interest in both BLM and Canopy. Appellants reached a tentative deal to purchase Lewis’ interest in BLM, but the parties could not agree on a deal for Canopy due to a stockholder agreement that included certain non-compete provisions. Appellants were unwilling to purchase Lewis’ interest in BLM unless Lewis agreed to the non-compete provisions in the Canopy stockholder agreement.

After failing to reach an agreement, Lewis brought an action against Appellants in which he moved the district court to force a buyout of his shares of BLM. The district court found that Appellants acted in bad faith and that their conduct towards Lewis was unfairly prejudicial because Lewis had “a reasonable expectation that he would be paid the buyout price of his interests in BLM even though there were other issues for the buyout of the Canopy Group.”

The district court appointed an appraiser to determine the fair value of BLM, after the parties failed to agree on a price. The court-appointed appraiser determined Lewis’ ownership interest in BLM was valued at $122,997. Appellants called a business appraiser to testify at the valuation hearing. Appellants’ appraiser testified that a 10% lack of control discount and a 25% marketability discount should be applied to the prior analysis to reach the fair value of Lewis’ interest in BLM. Appellants’ appraiser also pointed out an issue with the court-appointed appraiser’s calculation that lowered the original appraisal value of Lewis’ interest to $122,806. The district court found that $122,806 was the fair market value of Lewis’ interest. It did not apply any discounts for lack of control or marketability.

Appellants were ordered to pay one lump sum of $122,806 to Lewis, or agree to an alternative payment plan within 40 days. The parties could not reach an agreement. Subsequently, the district court ordered Appellants to pay Lewis monthly installment payments of $10,000 until the total amount plus interest was satisfied. Appellants appealed the district court’s decision and argued that the court erred in ordering the buyout of BLM because they had not frustrated Lewis’ reasonable expectations, that the court erred in its valuation of Lewis’ interest, and that the one year payment schedule would be unduly burdensome to the business.

Refusal to Negotiate can be Unfairly Prejudicial Conduct
Minn. Stat. § 322B.833, subd. 1 allows courts to “grant any equitable relief it considers just and reasonable in the circumstances” if “those in control of the limited liability company have acted . . . in a manner unfairly prejudicial toward one or more members in their capacities as members.” Minn. Stat. § 322B.833, subd. 1, 1(2)(ii) (2014). “The phrase ‘unfairly prejudicial’ is to be interpreted liberally.” McCallum v. Rosen’s Diversified, Inc., 153 F.3d 701, 703 (8th Cir. 1998).
The appeals court affirmed the district court’s finding that Appellants’ refusal to consummate the BLM transaction unless Lewis agreed to terms on the Canopy agreement was unfairly prejudicial conduct. Where the parties could complete the two agreements separately and distinctly from one another, the appeals court agreed that Appellants’ failure to negotiate was bad faith, and not a negotiation strategy. Appellants’ conduct was sufficient for the court to find that under principles of equity it could force a buyout of Lewis’ ownership interest in BLM.

District Court has Discretion in Process and Determination of “Fair Value”
Minn. Stat. § 322B.833, subd. 2 provides a process for determining the fair price of a minority owner’s interest in a company if the parties cannot agree on their own accord. “The court may, upon a motion of a limited liability company or a member, order the sale by a plaintiff or a defendant . . . if the court determines in its discretion that an order would be fair and equitable to all parties under all of the circumstances of the case.” “If the parties are unable to agree on fair value within 40 days of entry of the order, the court shall determine the fair value of the membership interests.”

According to the Minnesota Supreme Court in Advanced Commc’ns Design Inc. v. Follett, 615 N.W.2d 285, 289 (Minn. 2000), fair value is a shareholder’s “pro rata share of the value of the corporation as a going concern without a discount for lack of marketability,” absent extraordinary circumstances. Extraordinary circumstances include whether any shareholder “acted in a manner that is unfairly oppressive to the other or has reduced the value of the corporation, whether other remedies exists,” or “whether any condition of the buy-out, including price, would be unfair to the remaining shareholders because it would be unduly burdensome on the corporation.”

In Lewis, Appellants argued that the court’s valuation of Lewis’ ownership interest in BLM was too high because of BLM’s limited profits and cash flow, their belief that a lack-of-control or marketability discount should apply, and the additional burden to BLM of meeting the court-ordered payment schedule. The appeals court held that it was within the trial court’s discretion to determine a fair value that did not include a lack-of-control or marketability discount. Additionally, the appeals court confirmed that the trial court had discretion to determine an equitable payment schedule in the absence of an agreement by the parties, even if BLM would be forced, as Appellants contended, to liquidate real property to meet the cash flow requirements needed to complete payment within one year.

The take-away from the Lewis decision is that majority owners of an entity should be cautious when negotiating with a minority owner so as to avoid a finding of unduly prejudicial conduct or bad-faith in the negotiation. When the majority owners have acted in a manner that is unduly prejudicial, the court may order the other owners or the company to buy out a minority owner’s interest at a fair value that does not include any lack-of-control or marketability discounts. Additionally, if the parties do not agree on a payment schedule, the court may order a payment schedule without regard to the cash flow or profits of the company.

For advice on minority shareholder rights, buyouts, and other issues facing Minnesota businesses, contact one of the Minnesota business and commercial litigation attorneys of Trepanier MacGillis Battina P.A.
About the Author:
Minnesota shareholder dispute attorney James C. MacGillis advises clients on corporate and business law matters such as business entity formation, buy-sell agreements, and shareholder dispute litigation. Jim may be reached at 612.455.0503 or Trepanier MacGillis Battina P.A. is a Minnesota shareholder dispute law firm located in Minneapolis, Minnesota.