Forced Buyouts in a Business Divorce – Valuable Weapon or Trap for the Unwary?

by Jaburg Wilk
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Many part-owners of a business are not aware that, as shareholder of an Arizona corporation, they gain the right to seek to dissolve the corporation under certain circumstances, but at the same time subject themselves to mandatory buyout procedures which do not apply to other types of business organizations. 

Under the Arizona Corporation Statute, A.R.S. § 10-1430(C), a corporation may be judicially dissolved, on petition of a shareholder, upon a determination that:

  1. The directors are deadlocked in the management of the corporate affairs, the shareholders are unable to break the deadlock and irreparable injury to the corporation is threatened or being suffered or the business and affairs of the corporation cannot be conducted to the advantage of the shareholders generally because of the deadlock;
  2. The directors or those in control of the corporation have acted, are acting or will act in a manner that is illegal, oppressive or fraudulent;
  3. The shareholders are deadlocked in voting power and have failed for a period that includes at least two consecutive annual meeting dates to elect one or more directors; or
  4. Corporate assets are being wasted, misapplied or diverted for non-corporate purposes.

This statutory provision is, of course, a valuable weapon in the hands of a minority shareholder.  However, a companion section of the statute, A.R.S. § 10-1434, significantly limits its value and usefulness by providing that, in the case of non-publicly traded corporations, the corporation may elect, by notice given within 90 days of the filing of the action for judicial dissolution, to purchase the shares of the dissenting shareholder for “fair value.”  The statute further provides that fair value is to be decided by a judge, without a jury, who is entitled not only to set the price but also determine the terms of sale.

By way of comparison, the Arizona limited liability company statute, A.R.S § 29-795, provides for judicial dissolution of an LLC, on application of a member, on the grounds that:

  1. It is not reasonably practicable to carry on the limited liability company business in conformity with an operating agreement;
  2. Unless otherwise provided in an operating agreement, the members or managers are deadlocked in the management of the limited liability company and irreparable injury to the limited liability company is threatened or being suffered or the business of the limited liability company cannot be conducted to the advantage of the members generally because of the deadlock;
  3. Unless otherwise provided in an operating agreement, the members or managers of the limited liability company have acted or are acting in a manner that is illegal or fraudulent with respect to the business of the limited liability company;
  4. Unless otherwise provided in an operating agreement, substantial assets of the limited liability company are being wasted, misapplied or diverted for purposes not related to the business of the limited liability company.

While the grounds for dissolving an LLC are essentially the same, the statutes are different in one extremely important respect. That is, unlike a corporate shareholder, an LLC member bringing an action to dissolve the company is not subject to a mandatory buyout of his or her membership interest. 

Sophisticated business owners can take advantage of their knowledge of these statutes in a number of ways:

For the minority owner, these may include, under appropriate circumstances:

  • Causing the business to be operated in the form of a limited liability company, rather than a corporation,
  • Obtaining an agreement by the corporation and controlling shareholders to waive any statutory buyout rights, or
  • Causing the business to be incorporated under the law of another state (provided that the laws of that state otherwise are favorable to a minority owner.)         

Conversely, as the majority or controlling owner, the approach should be to resist any of the minority-owner strategies outlined above.  Depending on other considerations, including tax issues, the appropriate course of action may be:

  • Insisting that the business be operated in the form of an Arizona corporation, or
  • Having in effect a well-drafted operating agreement, with appropriate provisions requiring the purchase and sale of the minority owner’s interest at an agreed-upon price or formula.   

Of course, the best course of action in a given case will depend on the specific facts and circumstances, including, among other things, the terms of any existing agreements, the relative bargaining positions of the parties and the amount of money at stake.  

The experienced business attorneys at Jaburg & Wilk can assist the co-owners of a business at the formation stage, both in selecting the proper form of organization for their business and in drafting documents to protect their particular interests, whether as a minority or majority owner.  Alternatively, for co-owners who are already involved in disputes with their partners, we can provide effective and knowledgeable advice and assistance in resolving those disputes through negotiation or litigation.  


 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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