David M. Repp, Dickinson, Mackaman, Tyler & Hagen, P.C., Des Moines, IA
The Iowa Supreme Court has championed the cause of minorities on more than one occasion: slavery in In Re the Matter of Ralph (1839), allowing women the right to practice law (Arabella Mansfield – 1869), gay marriage in Varnum v. Brien (2009). Perhaps no one should be surprised by the Iowa Supreme Court’s decision in Baur v. Baur Farms, Inc. decided on June 14, 2013.
Baur Farms, Inc. is a family farm corporation (taxed as a C corporation) owned by three individuals, John “Jack” Baur, Dennis Baur and Bob Baur. Jack owns 644 shares (26.29%); Dennis owns 544 shares (22.20%) and Bob owns 1262 shares (51.51%). Jack and Dennis are brothers and Bob is their first cousin.
Bob, who has Ph.D. in economics and a full time job, does not farm the land, but he does manage it. Bob was charged by his father and uncle to maintain the corporation indefinitely for any Baur descendant who desired to farm the land. Jack’s nephew, James, now farms much of the land. In carrying out his charge, Bob desired to grow the farm by acquiring more farmland. Jack has never farmed and has tried to sell his shares ever since he inherited them from his father in 1989. Jack offered his shares to the corporation, to Bob and to James several times over nearly two decades, but the parties could not agree on a price. Jack then initiated suit in 2008 against Bob and Baur Farms, Inc. for fraud, illegality and oppressive conduct in violation of Iowa Code Section 490.1430(2)(b).
The Iowa Supreme Court found that Bob did not abuse his authority as majority shareholder through excessive compensation or perquisites. Nor did Bob mismanage the business of Baur Farms, Inc., waste its assets, self deal or violate any of his duties of due care and loyalty. Nevertheless, the Iowa Supreme Court indicated that Bob will likely need to buy his cousin’s stock, probably at an undiscounted price.
The court empathized with Jack’s unsuccessful efforts to sell his inherited shares all the while never receiving any dividends. So, the court provided Jack with a gift. It crafted a new standard of oppression of shareholders when the majority fails to satisfy the reasonable expectations of the minority at a time when the corporation has the financial resources to do so. This “reasonable expectations” standard essentially makes a market for those shareholders who do not have a controlling interest.
The Iowa Supreme Court remanded the case to the trial court because it had insufficient information in the record to determine whether Bob’s offers to Jack were so inadequate as to constitute actionable oppression. But how is the trial court to know whether Bob’s offers were inadequate? The Iowa Supreme Court gave some strong hints.
In footnote 5 of the opinion, the Iowa Supreme Court emphasized its disapproval of valuation discounts for lack of control or marketability. Later, the court all but outlawed discounts when it said that “every shareholder may reasonably expect to share proportionally in a corporation’s gains.”
Thus, upon remand, the trial court will be expected to compare the prior offers made by Bob to the proportionate value of the corporation’s assets. If Bob’s offers were deficient, oppression will be the verdict and the trial court will have an assortment of remedies to apply, including requiring Bob to purchase Jack’s shares. Saur v. Moffitt, 363 N.W.2d 269, 275 (Iowa Ct. App. 1984). The result seems circular: If Bob has not offered to pay Jack full proportionate value, then he has oppressed Jack and has to pay Jack full proportionate value.
If Bob is mandated to buy Jack’s 644 shares, as it appears he will have to do, Bob will also be confronted with the prospect of having to buy Dennis’s 544 shares.
What Are the Ramifications to Other Iowa Corporations and Shareholders? The implication of the Baur case seem clear: minority shareholders have gained significant bargaining power in negotiating their exit. Prior to Baur, the majority shareholder had to exhibit other bad behavior before being required to buyout the minority. Maschmeier v. Southside Press, Ltd., 435 N.W.2d 377 (Iowa Ct. App. 1988) (majority misapplied and wasted corporate assets); Saur v. Moffitt, 363 N.W.2d 269 (Iowa App. 1984) (majority mismanaged and took part in fraudulent acts). There were no bad acts in Baur; the oppression rested firmly on Bob’s reluctance to monetize Jack’s inheritance. One could say the Iowa Supreme Court granted all minority shareholders of Iowa corporations a “put option” exercisable in 20 years, or sooner depending on future case law developments.
What If Some Dividends Are Paid? There were no dividends paid by Baur Farms, Inc. over the entire 45 years of its existence. If some dividends were paid, would the Iowa Supreme have ruled differently? Probably not for two reasons. The first is that Jack and the other shareholder/directors were paid $5,000 in annual directors fees for several years which was essentially equivalent to a dividend. The other is that the briefing of the parties indicates Bob offered to pay dividends but Jack refused stating it was a bad idea for a C corporation to pay dividends. If dividends were important to the Iowa Supreme Court, it would have mentioned this fact in its opinion.
What About the Business Judgment Rule? Courts have historically given great deference to the business judgment of the majority owner even if it negatively impacts the minority owner. Matthew G. Dore, 6 Iowa Practice – Business Organizations § 28:6 (West 2012-2013 ed.). The Baur decision erodes this long-standing rule. Bob clearly established that he preferred to grow the corporation through further acquisitions of farmland. Jack established that he preferred to use the corporation’s capital to buy him out. The Iowa Supreme Court seems to suggest that Jack’s interest trumps Bob’s business judgment.
Majority owners of corporations with minority shareholders now have a new concern. Do they purchase a new farm or tuck capital away to buy out a shareholder.
What Happens If No One Is In the Majority? This was the facts of Maschmeier v. Southside Press, Ltd. 435 N.W.2d 377 (Iowa Ct. App. 1988). In Maschmeier, two children owning a combined 48 percent sued their parents owning a combined 52 percent. No single shareholder controlled the corporation but the parents, acting in concert, were found to have oppressed the interest of the minority shareholders.
What If a Buy-Sell Agreement Exists? The good news is that the Baur case validates the use of buy-sell agreements that include transfer price provisions, albeit, in the form of dicta. Page 16 of the opinion says that buy-sell agreements are enforceable if they are not manifestly unreasonable. The Iowa Supreme Court gave several examples of unreasonable on pages 14 and 15 that included 80 and 90 percent discounts (i.e. “unconscionable”). Perhaps more importantly, footnote 8, citing to Lange v. Lange, 520 N.W.2d 113 (Iowa 1994), indicates that a court should apply ordinary principles of contract interpretation to stock transfer restrictions. What this seems to suggest is that shareholders will have broad latitude in crafting their own buyout terms in advance of disputes, and they can expect to have the terms enforced.
An example of a buyout term may be a “put option” exercisable by any shareholder at a 30 percent discount from the value of the corporation’s assets. If such a provision existed in Baur Farms, Inc., there likely would not be a Baur case.