Selected Legal Issues
Why Have a Buy/Sell Agreement?
- Basic purpose is to provide for an orderly transition of ownership interests on the occurrence of specified events (anticipating potential conflicts that may upset the operations of a company, such as where a third party makes an offer to buy the shares of one of the shareholders).
- Benefits to the entity and owners include:
- Allows remaining owners to determine with whom they will work and share control of the entity.
- Prevents outsiders/heirs, whose interests may conflict with those of the entity or the remaining owners, from obtaining an ownership interest, through such mechanisms as rights of first refusals, tag along rights, market maker offer provisions.
- Can also be utilized to force a sale of shares through buy out offer provisions or drag along rights.
- Ensures continuity of management and control by the remaining owners.
- Prevents the loss an S corporation election by preventing a transfer of the interest to an unqualified shareholder (e.g. a corporation) or to a shareholder who refuses to elect S corporation status.
- Increases job stability for minority owners and key non-owner employees.
- Provides for orderly liquidation of owners’ interest in the event of death, permanent disability, or other contingencies (e.g. incarceration, bankruptcy).
- Creates a market for the shares of deceased, disabled, withdrawing owners.
- Generates cash to pay death taxes and estate settlement costs.
- Fixes the value of the interest for estate and gift tax purposes.
- Can be a vehicle for establishing special supermajority voting conditions (e.g. 2/3rds consent required for special transactions such as asset transfers, incurrence of significant debt) and for establishing limitations on a shareholder’s ability to compete with the company subsequent to the sale of his ownership interest.
- Can provide a vehicle for resolving disputes between shareholders (e.g. mandatory mediation/arbitration provisions). Who will be a client or the firm for purposes of this transaction, in addition to the company?
Oral Contracts and When Written Contracts are Necessary
- An oral agreement is binding on the parties in the absence of the applicability of the statute of frauds (see below). However, where the parties fail to memorialize their agreement in writing, this increases the likelihood that disputes may arise in the future (and ultimately, litigation) as to the terms, scope and interpretation of the contract. Without a formal document, it is much easier for the parties to enter the contract with fundamental disagreements about what was intended, what were the objectives etc.
- Under California law, the statute of frauds requires that certain types of contracts be supported by a writing if they are to be enforceable. The statute provides only a defense, and cannot be used to enforce an agreement. Agreements governed by the statute of frauds include:
- Agreements incapable of performance within one year.
- Certain agreements relating to the purchase, sale or lease of real property.
- Agreements incapable of performance during the lifetime of the promisor.
- Suretyship agreements (e.g. promise to a creditor to meet the obligations of another).
- Certain agreements to make a consumer loan in excess of $100,000.00.
- Certain agreements for the assumption of indebtedness secured by a deed of trust on property purchased.
- Certain modification agreements.
- Certain agreements for the sale of goods in excess of $500, and certain agreements for the sale of personal property in excess of $5,000.
- Letters of credit.
- Authorization of another to enter into an agreement that must be in writing.
- Certain equipment leases.
- Agreements to pay the debts or liabilities of a decedent from one’s own estate.
- A trust in relation to real property.
- Premarital agreements.