The following paragraph is from an actual buy-sell agreement.
1. Divorce or Bankruptcy of a Shareholder. Upon the occurrence of the entry of a final decree of bankruptcy or divorce (each hereinafter referred to as a “Triggering Event”), such affected Shareholder’s stock in the Corporation may, at the Corporation’s option, be sold to and purchased by the Corporation upon the following terms and conditions.
(a) Purchase Price. The purchase price paid will be the affected Shareholder’s proportionate ownership interest in the Corporation multiplied by the Corporation’s Fair Market Value, as defined in Section 6.B. hereof as of the date of the Triggering Event, less a twenty percent (20%) discount.
This language can provide for what might clearly be perceived by the parties as unintended consequences. I am not an attorney and do not offer legal advice. As always, I provide my thoughts as a valuation professional and a business man. If you have questions or concerns about the legal issues with your buy-sell agreement, consult your attorney immediately. Now, back to the paragraph:
- First, I would consider separating divorce and bankruptcy clauses, since they have such potentially different economic and personal impacts.
- The intent of the agreement with respect to divorce is not clear. Normally, clauses pertaining to divorce in buy-sell agreements are there to prevent a court from awarding stock to the non-shareholder spouse in the divorce settlement. This clause says that if any shareholder gets divorced under whatever circumstances, even if the stock is unaffected, the Corporation shall have the right to buy the stock.
- In bankruptcy, the Corporation would like to have the right to purchase the shares to keep them from being sold by the bankruptcy estate. Again, I am not a lawyer, but one could question whether the agreement would be binding on the bankruptcy estate if the Corporation has only the right, but not the obligation, to purchase the shares. That would, of course be up to the court to determine. But there is perhaps some uncertainty there.
- Finally, after discovering that the Corporation can buy an owner’s shares in the event of divorce or bankruptcy, it might add insult to injury to discover that the buy-sell agreement provides for a 20% haircut from the otherwise determined purchase price.
The interesting thing about this provision is that an owner could find himself (assume all guys with this one) both out of the house and on the street looking for another job! Also assume there were several shareholders involved with the agreement. The probability of there being one or more divorces among the group was clearly greater than zero. The provision is truly a ticking time bomb, and may not lead to reasonable resolutions in the event of divorce among the ownership group.
I am not sure that all the parties to the agreement read it carefully. If they had, someone surely would have objected to giving the Corporation the right to acquire the shares of any owner who divorced, even when the shares might not be in danger of being awarded to on out-spouse.
This post illustrates the point I have made many times in my book, Buy-Sell Agreements for Closely Held and Family Business Owners, and in this blog. If you have a buy-sell agreement, it is important for you to read it and to understand what it says.
If there are problems with the agreement, the time to “fix” it is now, before there is a trigger event and before the interests of the parties (the Corporation and the other shareholders) have diverged as result.
To find out even more about the issues mentioned in this post, continue to read this blog. You can accelerate the learning process by getting the book Buy-Sell Agreements for Closely Held and Family Business Owners. Please share the blog with your friends, advisers, and colleagues. We’ll be providing fresh insights as we continue to explore buy-sell agreements and and how to make them work, as well as other interesting valuation-related issues.