Court Voided Board Approval of Book Value Stock Issuance to Director

Introduction

The founder of a company often wants to pass the business on to his kids when he or she is ready to slow down. The founder also often wants to control the business after the transfer. That is what happened here.

The deal

The founder built, owned and operated a Dodge, Chrysler and a Toyota car dealership, based in Texas. One of the founder’s sons was active in running the family business.

Eventually, the founder started to shift control of the business to his son. Each dealership was operated out of a separate limited partnership. There were two related limited partnership that held dealership real estate.

The general partner and manager of each limited partnership was a corporation. The son owned all 1,000 issued and outstanding shares of this management company. However, the founder held a proxy to vote his son’s shares and thus, dad was the sole director and president of the management company. The son’s shares had no preemptive rights; meaning that he had no right to purchase additional shares to prevent dilution of his 100% stock interest.

The founder and son had a falling out and shortly before his death the founder as sole director of the management company authorized the issuance to him of 1,100 shares of the management company’s stock for $3.2 million. The price was determined by the founder’s accountant based upon the company’s book value. The company was worth substantially more than book value.

The lawsuit

The son learned of the 1,100 shares stock issuance to his father after his dad died. The son then asked a Texas court to void the 1,100 shares stock issuance, claiming that his dad, as sole director, breached his fiduciary duty under Texas corporate law that he owed to his son, as shareholder, by approving the issuance of stock to the father at book value.

The son was successful. On appeal the court noted that the transaction would have been legal had it been fair to the son, even though the father was self-dealing. But a book value purchase price was too low and thus not fair.

This case is referred to as In the Matter of the Estate of Poe, No. 08-18-00015-CV, Court of Appeals of Texas, Eighth District, El Paso (August 28, 2019)  

Comment

The court noted that the son “presented testimony criticizing the use of book value. For instance, … (the founder’s accountant) … spent about an hour calculating the stock price based on book value, while a fair market value determination would have taken four to six weeks.”

There are several ways to manage the risk that a stock deal between a company and one of its directors will hold up under legal scrutiny. One way is to have a credible valuation of the transaction by an independent valuation consultant with experience in valuing the business involved and a good reputation in the industry.

By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million).

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

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