The Importance of Buy-Sell Agreements: Two Cases Spell Out What Can Go Wrong
Business Valuation Advisor, Summer 2007

Fausak’s Tire Center, Inc. v. Blanchard, 2006 Ala. Civ. App. LEXIS 719 (December 8, 2006) and Bullet Land, Inc. v. Thal, 2006 U.S. Dist. LEXIS 88521 (December 7, 2006)

These two cases highlight the many problems associated with buy-sell agreements—and the ways attorneys and business appraisers can help clients avoid them.

Death of a shareholder

In the Fausak case, three brothers bought a company for $1.1 million, or $2,100 per share; the sole asset was a tire store on a piece of real property. For the next three years, they discussed the need for a buy-sell agreement, drafted at least four different versions, and purchased life insurance policies to fund a buy-sell—but failed to formalize the terms. Two years later, the shareholders modified the purchase price of the company stock to $2,500 per share, which all agreed was fair. But it took another couple of years, after one of the brothers died, for the remaining shareholders to execute a buy-sell agreement fixing the stock at $2,500 per share.

At the time of his death, the shareholder owned a 20 percent interest in the tire business, which the company valued at nearly $17,000 (the record does not clarify how this value was reached). The company also valued the decedent’s 125 shares at the $2,500 price, for a total of $312,500. Accordingly, the remaining shareholders offered the widow a total of just under $333,000 to buy out her husband’s interest, less a $15,000 advance they had made to his estate.

Although the widow cashed the $15,000 check (which was endorsed “for advancement buy/sell agreement”) she apparently balked, perhaps believing that given the company’s growth since her husband’s death, its per-share value had risen as well.

The company tried to argue that the shareholders’ agreement to modify the purchase price of the stock to $2,500 was a “note or memorandum” sufficient to establish the terms of a buy-sell agreement at the time of the death—as further evidenced by the widow’s cashing of the $15,000 advance. The probate court disagreed, however, as did the Court of Appeals on review. To satisfy the applicable Statute of Frauds, any writing must contain the “essential terms” of the alleged agreement, including, in the case of a buy-sell, the “mutual assent” of the signing parties to its purpose:

[T]he problem with considering the stock-valuation document as a memorandum…is not that the document might have been intended for some purpose other than a buy-sell agreement, but, more fundamentally, that it is simply insufficient to evidence a buy-sell agreement at all.

Even written buy-sells cause problems

The Fausak case shows what can happen when parties delay too long in implementing a buy-sell agreement. The Bullet Land case illustrates what can happen when the terms aren’t sufficiently spelled out, especially those concerning the binding effect of the appraisal(s) involved.

The Bullet Land partnership was formed to renovate and operate a historic hotel. In early 2006, the general partner received and consented to a written notice of removal. The partnership’s buy-sell agreement involved five basic steps: 1) each party selects an appraiser; 2) those two appraisers select a neutral third appraiser; 3) the three appraisers collectively determine a fair market value; 4) if the three appraisals differ, the lowest value is disregarded and the two higher values are averaged; and 5) the average is submitted to a CPA to determine the final purchase price.

All of the steps took place. The general partner and the partnership each selected an MAI appraiser, who then selected a third, neutral appraiser. The appraised values for the entire partnership came back at $17.1 million, $13.4 million, and $12 million, respectively. The latter (from the neutral appraiser) was tossed out, and the buyout price for the general partner’s interest was calculated to be $3.6 million, based on the remaining two appraisals. An independent CPA confirmed the buyout price, and the deal appeared ready to close, per a letter from Bullet Land’s counsel confirming the “agreement of the parties.”

But then the neutral appraiser sent a report to Bullet Land’s lawyer, stating that the $17.1 million appraisal was “not credible” because it was based on inappropriate comparable data and projections that were not “supported by market evidence and…conditions.” What followed was a lawsuit in which both parties disputed the facts as well as the claims—the partnership attacking the $17.1 million appraisal and the general partner trying to enforce the buyout price as an arbitration award.

Buy-sell is not an arbitration agreement

In the end, the parties’ only agreement was that the appraisal process had failed to bring about a purchase. Despite the near closure of the buy-sell process, the Court found it did not constitute an arbitrated settlement agreement and denied the general partner’s motion to dismiss—leaving all parties exposed to further litigation and costs.