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Voluntary
Dissolution And The Corporation’s
Power To Purchase
Shares Of Stock Via Corporations Code Section 2000
INTRODUCTION:
As discussed in our
article on
Corporate Struggles: Who Has
the Power When Push Comes to Shove, the struggle for
control of operations or access to economic benefits in a California
corporation can run the gamut from fights for control of officer
positions and/or employment by the Company to control of the Board of
Directors. Ownership of shares and contractual rights usually determine
who can win in such disputes.
It is not uncommon
for a shareholder who is stymied in seeking effective control of a
company to decide to abandon the company or begin a new one thus to seek
access to such corporate assets as good will, customer lists and
employees. Such actions are contrary to the interests of the
corporation, of course, and breach of fiduciary duty can prohibit that
attempt. See our article on
fiduciary duty.
However, one way such a shareholder can seek to still obtain those
assets is by eliminating the corporation as an entity entirely. The
shareholder can seek to dissolve the company, to “kill” the company.
A shareholder of a
California corporation owning fifty percent or more of the shares has
the right to initiate, even against the wishes of the other owners, a
Voluntary Dissolution of the Corporation pursuant to the
California Corporations. Code Section 1900. However, as set forth below,
Cal. Corp. Code Section 2000 provides the other shareholders wishing to
halt the dissolution an effective remedy if the shareholder only owns
fifty percent of the shares.
The other
shareholders can apply to a court to exercise the absolute right to
purchase (or to have the corporation purchase) the shares of the party
desiring the liquidation for “liquidation value.” Any such application
automatically stays the dissolution.
Once the court
(through three appraisers) has valued the shares, the shareholders
contesting the dissolution have the right, but not the obligation, to
purchase the shares.
The basic details of
the procedure are discussed in this article.
BASIC LAW:
Cal. Corporations Code section 2000
provides as follows.
Subject to any
contrary provision in the articles, in any...proceeding for voluntary
dissolution initiated by the vote of shareholders representing only 50
percent of the voting power, the corporation or, if it does not elect to
purchase, the holders of 50 percent or more of the voting power of the
corporation (the “purchasing parties”) may avoid the dissolution of the
corporation and the appointment of any receiver by purchasing for cash
the shares owned by the...shareholders so initiating the proceeding (the
“moving parties”) at their fair value.
However, if the
purchasing party, after receiving the evaluation, does not elect to
purchase the shares, they could be liable for the moving party’s costs,
including attorney’s fees. Moreover, upon filing the action, the
purchasing parties have to post a bond to cover these anticipated costs
and fees. The bond would not be expensive but is required.
Notice that the
corporation can elect to purchase the shares. This is important
because, as the legislature noted in its legislative history:
Frequently, the only
source of sufficient cash to avoid dissolution is the corporation. In
order that the statutory “buy-out” procedure establishes a meaningful
alternative to termination of the enterprise, this section provides the
corporation with the first right to purchase the shares of the moving
parties.
Accordingly, the
corporation has the ability to purchase the shares.
Further, note the
following statutory provision:
The election of the
corporation to purchase may be made by the approval of the outstanding
shares (Section 152) excluding shares held by the moving parties.
This is a truly
critical power since it means that the party who sought involuntary
dissolution can not vote on whether to invoke the powers of Corp. Code
Section 2000 and use the corporation itself to purchase his or her
shares at “liquidation” value as appraised by the Court appointed
experts. Suddenly, the power to make the decision is vested in the other
shareholders. Utilizing Corp. Code Section 1900 can be a dangerous move,
indeed.
(Be sure not to
confuse this petition for voluntary dissolution for an adversarial
petition for involuntary dissolution. The grounds for involuntary
dissolution are that:
(4)
Those in control of the corporation have been guilty of or have
knowingly countenanced persistent and pervasive fraud, mismanagement or
abuse of authority or persistent unfairness toward any shareholders or
its property is being misapplied or wasted by its directors or
officers.)
KEY QUESTION: PRICE:
WHAT IS “FAIR VALUE?”
The statue defines
the critical question as to how the price of the shares to be purchased
from the moving party shall be determined. The fair value shall be
determined on the basis of the liquidation value as of the
valuation date but taking into account the possibility, if any, of sale
of the entire business as a going concern in a liquidation.
Note that the
liquidation value is less than fair market value because it seems to
contemplate an involuntary sale. It does appear, however, to
contemplate an aspect of goodwill. The statute continues as follows:
In fixing the value,
the amount of any damages resulting if the initiation of the dissolution
is a breach by any moving party or parties of an agreement with the
purchasing party or parties may be deducted from the amount payable to
such moving party or parties, unless the ground for dissolution is that
specified in paragraph (4) of subdivision (b) of Section 1800.
Thus, if there were
any agreements which may have been breached by the moving party in
seeking dissolution, the damages from that breach may be indirectly
obtained by reduction in the value of the stock. .
If the parties are
unable to agree to a price, a court may stay the dissolution and set the
price after the posting of a bond:
If the purchasing
parties (1) elect to purchase the shares owned by the moving parties,
and (2) are unable to agree with the moving parties upon the fair value
of such shares, and (3) give bond with sufficient security to pay the
estimated reasonable expenses (including attorneys’ fees) of the moving
parties if such expenses are recoverable under subdivision c, the court
upon application of the purchasing parties, either in the pending action
or in a proceeding initiated in the superior court of the proper county
by the purchasing parties in the case of a voluntary election to wind up
and dissolve, shall stay the winding up and dissolution proceeding and
shall proceed to ascertain and fix the fair value of the shares owned by
the moving parties
The court ascertains
the price by appointing three disinterested appraisers to do the
work. This decision is final. Once this process has concluded, the court
orders the purchasing party to pay the price within a set time, and
after the payment, the remaining shareholders become the sole owners.
They, of course, would have the full right to protect all corporate
assets, including employees, goodwill, etc. as discussed in other
articles.
If the purchasing
parties do not make payment for the shares within the time specified,
the dissolution moves forward and judgment is entered against them and
the surety on the bond for the amount of the expenses (including
attorneys fees) of the moving parties.
Once the fair value
is set on the shares of stock held by the non-majority shareholder who
wishes to dissolve the corporation, the purchasing parties have the
right, but no corresponding obligation, to purchase the moving parties’
shares at the fair value price. Mart v. Severson (2002) 95
Cal.App.4th 521.
CASE LAW ON SETTING
VALUE:
In Mart v.
Severson, supra, plaintiff and defendant each were 50% shareholders
and directors of B corporation. When plaintiff requested court
supervision in the voluntary winding up of B, defendant exercised his
section 2000 right to purchase plaintiff’ shares at their fair value in
order to avoid dissolution. Three appraisers were appointed and they
determined that B could be sold as a going concern, and using both
“income approach” and “market approach” valuation methods, determined
the fair value of 100% of B's common stock to be $5.6 million.
Defendant argued for a liquidation value. The appraisers had rejected
the liquidation value method because that approach was commonly used
when companies are insolvent, the tangible assets sold piecemeal, the
liabilities retired, and remaining equity distributed to shareholders.
The appraisers concluded that approach was irrelevant here because of
B’s historical earnings records and future earnings capability. The
appraisers did not adjust their valuation to account for potential
future competition by shareholders and assumed that hypothetical
covenants not to compete would be executed by the shareholders and key
employees. The trial court directed that non-competition covenants be
submitted and that the appraisers conduct an appraisal using the
liquidation method. The appraisers found a liquidation value of $1.48
million. The trial court found the non-competition agreement submitted
by plaintiff to be ineffective and untimely because the agreement did
not exist as of the valuation date. The trial court adopted the
piecemeal liquidation value and issued its decree and judgment winding
up and dissolving B.
The court of
appeals reversed, holding as follows.
(a) The trial court
misinterpreted Section 2000. The court held that the statute provides a
method for establishing a fair value price of a moving party’s stock; it
neither governs nor addresses covenants not to compete or other terms of
a sale under which a purchaser may buy out the shares of the moving
party. Moreover, the court held that the section does not permit the
trial court to require, or evaluate the validity of, a covenant not to
compete.
(b) The court also
held that the valuation date for voluntary dissolutions is the date the
proceeding is initiated. Substantial evidence established that the fair
value of B’s shares as of the valuation date was $5.6 million. The
court stated that liquidation value under Section 2000 can mean going
concern value if the corporation could be sold as a going concern in
liquidation. Thus, the hypothetical question posed by Section 2000 is
whether the entire corporation could have been sold as a going concern
in liquidation on the valuation date. To answer that question, the
appraisers considered hypothetical reasonable sellers, hypothetical
reasonable buyers, and a hypothetical forced sale liquidation
environment. (95 Cal.App.4th at 533.) Evidence that
plaintiff would not give defendant a covenant not to compete prior to
the valuation date was not relevant to the appraisers’ scenario. (95
C.A.4th 533.)
In Trahan v.
Trahan (2002) 99 Cal.App.4th 62, plaintiffs and
defendants were the sole shareholders of T corporation, a business
providing sheet metal and general contracting services. Plaintiffs
together owned 50% of the shares, as did defendants. On May 30, 2000,
plaintiffs executed an election to dissolve T. At that time, T had a
backlog of outstanding construction contracts. Defendants sought to
avoid dissolution by purchasing plaintiffs’ shares and, failing to agree
on fair value, petitioned the court to stay the dissolution and to fix
the value. The trial court ordered that the fair value of T’s shares as
of May 30, 2000, the valuation date, be determined on the basis of the
liquidation value as of that date, taking into consideration the
possibility of T being sold as a going concern. The appraiser concluded
that T could not be sold as a going concern, and assigning no value to
outstanding and unperformed contracts, determined that the fair value
was a negative amount. The trial court confirmed the appraiser’s
award. The court of appeals affirmed, noting that plaintiffs never
requested that the trial court exercise its discretion and defer the
valuation date to allow the backlog of construction contracts to be
completed. In addition, plaintiffs neither suggested that T could be
sold as a going concern, nor did they challenge the appraiser’s
conclusions as to the liquidation value excluding the outstanding
contracts. Thus, the court of appeals concluded that substantial
evidence supported the trial court’s confirmation of the appraiser’s
determination of the fair value based on piecemeal sale of the assets as
of the valuation day.
SOME TACTICAL
THOUGHTS
As with all the
powerful tools available in corporate warfare, both Corp Code 1900 and
Corp Code 2000 must be very carefully analyzed and various scenarios
pondered before a petition is filed. The aggressive party seeking to
liquidate the company may find him or herself forced to sell at
liquidated value (or not…see above cases) and what was a power grab
becomes a surrender of a valuable asset below value. Likewise, the party
facing an attempt at dissolution should realize that it can be
stopped…but it may require a cash buy out, albeit using corporate
resources.
This should be seen
as just one more tool in the toolbox of those available in struggles
within a corporation. To use it without considering alternatives would
be a mistake and the time to determine the “game plan” is before…not
after…steps are actually taken. |
