Minority Shareholders in M&A Transactions

By D. Joe Rockett

When planning for a sale or merger of your business, planning ahead for potential problem areas is essential. Many privately held businesses have a group of owners who hold small minority interests who, variously, came onboard as friends and family of the founder, were added as the result of an acquisition years ago, or are investors who joined the Company over time under various circumstances. To minimize future problems, planning for the fair and equitable treatment of these minority holders is time well spent.

If the Company is to be merged out of existence, and the acquiring entity is averse to the idea of continuing the business with owners of small equity interests (hopefully for legitimate business reasons), the minority holders may be cashed out under the terms of the plan of merger. If the Company is a corporation, the shareholders, in lieu of accepting the merger consideration, may dissent from the merger and pursue their statutory appraisal rights, with the Company paying cash for the dissenting interests. In Oklahoma, appraisal rights are available in mergers, consolidations and, if provided for in the certificate of incorporation, in a sale of all or substantially all of the Company assets. Planning in this situation will need to address the time and cost potentially involved in an appraisal proceeding and the financing of the cash buyout of the dissenters at the judicially determined appraised values. To be entitled to an appraisal, dissenting shareholders must strictly follow the statutory procedures (in Oklahoma, see 18 O.S. 1091 D).

If the Company is an Oklahoma limited liability company or partnership, statutory appraisal rights will not be available (Oklahoma’s legislature has resisted adopting a statutory appraisal process for minority holders in a limited liability company) and the minority interest holders will be forced to take the cash offering price or seek other, very uncertain, alternatives through litigation, based on fraud, oppression of minority members or breach of fiduciary duty. The great uncertainty of litigating oppression of minority equity holders rights is well illustrated in a 2014 Texas Supreme Court decision, Ritchie v Rupe, 443 SW3d 856, in which the Texas court held there is no common law cause of action for oppression of minority shareholders in a Texas corporation. Occasionally, appraisal rights are included in the limited liability company operating agreement or partnership agreement. In the absence of such a contractual right to an appraisal and in the absence of fraud, oppression or breach of fiduciary duty by the majority, giving rise to a cause of action by the minority holders, such minority holders will be at the mercy of the controlling shareholder(s).

If not structured as a merger or consolidation, the transaction may be a sale of assets or a sale of stock or LLC interests, in which case the minority holders may be contractually bound to join in the sale under a “drag along” provision. A drag along provision often is included in limited liability company operating agreements or in corporation shareholder agreements. The essence of such a provision is that the control person or group in the selling entity can compel the minority equity holders to accept the terms of a purchase offer. In the absence of a drag along or comparable provision, the minority holders likely will have the option of either accepting the offered consideration for their interests, or retaining their interests.

In the planning process, thought may be given to making a buyout offer to the minority equity holders prior to the larger sale or merger transaction. That alternative can be fraught with some tricky disclosure and valuation issues, such as the likelihood of the merger happening or not happening and, if it happens, when. What is the Company’s best estimate of the valuation in the merger transaction, compared to the valuation in the pre-merger minority buyout offer? There may be business reasons that the purchaser will not allow the pre-merger disclosure of the merger consideration and the seller may concede important negotiating leverage by disclosing an estimate of the merger consideration. Securities issues as well as fiduciary duty issues require careful analysis in connection with a pre-merger buyout offer to the minority holders.

In the merger or sale transaction, if the minority holders have a decision of either taking the offered cash consideration or accepting an equivalent interest in the surviving entity, that is an investment decision involving a sale of securities that is subject to the requirements of both state and federal securities laws. The constituent parties to the merger or purchase and sale agreement, and their advisors, must be wary of the requirements of such laws.

Likely, an exemption from registration under such securities laws will be available, but keep in mind that such exemptions from registration do not exempt the parties from the anti-fraud provisions of securities laws. Thus, full disclosure by the Company, and documentation of the level of knowledge, sophistication and financial resources of the offerees will be important.

Nothing takes the place of careful planning and anticipating the challenges in the journey ahead. By no means has this brief blog been an exhaustive treatment of such challenges. Rather, these few observations hopefully will encourage some advance planning for the fair, equitable and compliant treatment of minority equity holders.

Our blogs are for general information purposes and are not intended to be, and should not be taken as, legal advice. The views expressed in this blog are those of the author and do not necessarily reflect the views of the firm.

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