New Developments

Virginia Supreme Court on transfer restrictions

The Supreme Court of Virginia has upheld a restriction on transfer that provided that an employee’s ownership of shares ends immediately upon cessation of employment for any reason. In Barber v. VistaRMS, Inc., Barber was issued shares in VistaRMS apparently for no money consideration, presumably as part of his compensation as an employee. The shares were issued pursuant to agreements that made the shares nontransferable without the express written consent of the original shareholders. The agreements also provided that if Barber left the company’s employment for any reason his “ownership … shall immediately cease. In such an event, the shares … shall be reallocated in accordance with the terms” of certain agreements. Barber was terminated and about a year later learned that the management began discussions leading to the sale of the company to a third party. Barber sought inspection rights for the purpose of ascertaining the value of his shares in such a buyout. VistaRMS refused on the ground that Barber was not a shareholder. Barber sued for inspection.

Justice Koontz, speaking for a unanimous court, held the restrictions on transfer enforceable and held that Barber was not a shareholder. On those grounds the court denied inspection rights. Barber argued several theories, but two are of interest. First, Barber argued that the restrictions violated the Virginia statute permitting restrictions for any “reasonable purpose”. Barber argued that the forfeiture of his shares did not serve a reasonable purpose. Justice Koontz held the statute inapplicable because the termination of Barber’s ownership interest was not a transfer. Barber also argued that the forfeiture provisions are unenforceable as against public policy. The court rejected that argument finding that the forfeiture provision was tailored to effect original shareholder’s desire to restrict ownership to themselves and certain employees.

The forfeiture provision is clearly a restriction on transfer and thus certainly comes within the ambit of the Virginia statute, contrary to the court’s holding. The provision that the shares shall be “reallocated” in accordance with a prior agreement is obvious evidence that the shares are available to the corporation for reissuance. Barber’s shares were, in fact, “transferred” pursuant to a “restriction”. The court simply dodged the issue of whether the restriction on transfer is enforceable according to its terms. That issue is addressed by Harrison v. NetCentric Corp. (casebook page 229) and Man o’ War Restaurants v. Martin (casebook page 233). My own sense is that the restrictions should be enforced but not because they aren’t governed by the statutory requirement of reasonable purpose. In the absence of overreaching or other equitable consideration, the agreement the parties made should be enforced. However, the Martin court would surely have trouble enforcing this restriction without fair compensation to Barber.

Wyoming Supreme Court on minority discount in determining “fair value”

The Wyoming Supreme Court has held that a minority discount is impermissible in calculating the fair value of a dissenting shareholder’s shares. In Brown v. Arp and Hammond Hardware Co., four cousins owned a corporation. The four agreed to sell a large portion of the corporation’s assets to an entity owned by one of the cousins. They then decided to sell their stock instead of the assets, but one cousin, Brown, disapproved. She desired to sell the assets but was unwilling to sell her entire ownership interest. The other three cousins sold their shares and the purchasing entity then effected a reverse stock split to cash out Brown. Brown perfected her right to appraisal and the primary issue was whether a minority discount should be applied.

Justice Burke held that a minority discount should not be applied. The Wyoming statute is substantially equivalent to § 13.01(4) of the MBCA before the 1999 amendments and does not speak to whether a minority discount is appropriate. After a decent discussion of the background of appraisal rights, Justice Burke noted that states were split on the issue of minority discount at the time Wyoming adopted the MBCA. Later, however, the Delaware Supreme Court decided Cavalier Oil Corp. v. Harnett, which held that minority discounts are inappropriate and most other states have since followed that decision. Justice Burke cited Matthew G. Norton v. Smyth, casebook pate 664, for the proposition that rejecting minority discounts is consonant with the pre-1999 MBCA.

One of the corporation’s arguments in favor of applying a minority discount was that ascertaining fair value is fact-intensive and that the facts here suggest that the objecting shareholder’s mother (who gave her shares to Brown shortly before the reverse stock split) was “troublesome, meddling, [and] difficult”. Justice Burke held that these facts are not “extraordinary circumstances” warranting a discount and noting that the “extraordinary circumstances” exception permits a marketability discount, not a minority discount.