By Ryan Olson
I recently encountered two clients who were having trouble divesting a third minority shareholder out of their business. The two clients together held a majority interest of a closely-held corporation and they wanted to buy-out the minority shareholder and continue on with the business without him. The parties were stuck in negotiations over price of the minority shares for over two months. The clients were in a tough position until we considered a cash-out merger to divest the minority shareholder.
A cash-out merger, also sometimes referred to as a ‘squeeze-out merger’ or ‘freeze-out merger,’ is one in which the existing corporation is merged with another corporation, the majority shareholders receive shares of stock of the surviving corporation, but one or more dissenting shareholders receive only cash or other property and are thereby eliminated as shareholders.
There are several key requirements that must be met in order for the cash-out merger to work properly, including:
- Buy-Sell Agreement / Corporate Action – The first major hurdle to overcome is the shareholder buy-sell agreement. – In order for the cash-out merger to work, the buy-sell agreement or any other corporate governance document must not govern what happens in the event of a merger.
- Typically, buy-sell agreements only govern what happens when one or more shareholders want to sell their shares and to whom they can sell to and under what conditions.
- By contrast, a conversion of shares in the merger is not considered a sale, transfer, or exchange within the meaning of most shareholder agreements because such mergers are not acts of the shareholders; rather, mergers are corporate acts by the directors.
- Fiduciary Duties – In order to avoid a breach of fiduciary duty claim, majority shareholders need to be sure to employ a fair process and pay the minority shareholders a fair price.
- Fair process in this context means full disclosure of the statutorily required information for the merger notice to shareholders. Fair process also means that the majority shareholders cannot do anything that will artificially depress the price paid to the minority shareholder for his interest.
- Fair price means the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable. MCL § 450.1761.
- Dissenter’s Rights / Appraisal – If a minority shareholder disagrees with the consideration payable for his or her shares under a plan of merger, the shareholder is generally entitled to dissent from the merger and obtain payment of the fair value of his or her shares through the appraisal process. MCL 450.1762(1). Generally, absent exceptions for illegality and fraud, appraisal is the sole remedy available to a minority shareholder, even in a conflict transaction, so long as the shareholder’s complaint is that he was paid less than the fair value of his shares.
In addition to the factors above, there are many other financial and legal considerations to think about before implementing a cash-out merger. Majority shareholders interested in cashing out minority shareholders are wise to involve trusted corporate counsel and financial advisors from the start, so that all of the proper steps are taken along the way and the merger runs as smooth as possible.
Contact your Dawda Mann corporate counsel if you are interested in learning more about cashing out a minority shareholder.