Corporations with multiple Shareholders should have a Stockholders Agreement.

Last month, I received a telephone call from a client that was involved in a corporate “divorce”. The client called in a “panic” and said that he and his co-shareholders were in a “nasty” dispute and that they did not have a Stockholders Agreement. Lacking that agreement, the “split-up” was becoming contentious!

The client related the story of how his “partner” was trying to sell his shares in their business at an inflated price to a third party (indeed, the third party was a competitor of their business). The member did not want to allow the competitor into the business! Unfortunately, there was little that he could say or do under the circumstances. I remarked that if the shareholders had chosen to utilize a simple Stockholders Agreement, the problem might have been avoided! A Stockholders Agreement would have set forth the rights and responsibilities of the shareholders to one another and to the corporation. The Agreement would have provided a clear and concise mechanism to resolve the dilemma.

So, what is a Stockholders Agreement? It is an agreement (often called a “buy-sell” agreement) whereby the corporation (and/or its shareholders) has either the right or the obligation to purchase the stock of a shareholder upon the occurrence of a specified event. The event might be the death, disability, retirement or withdrawal of a shareholder, etc. The Agreement might also provide for a restriction on sale of shares to a third party (i.e.: a “right of first refusal” retained by either the corporation and/or the remaining shareholders to purchase the offered shares).

There are two basic types of Stockholders Agreements (i.e.: a “Redemption Agreement” and a “Cross-Purchase Agreement”). Both the Redemption Agreement and the Cross-Purchase Agreement share the “same goal” (i.e.: to restrict the transfer of stock and to keep it out of the hands of “outsiders” who might want to disrupt the operations of the business).

Generally speaking, the parties to a Redemption Agreement are the corporation and its shareholders. Upon the occurrence of a specified event, the corporation must purchase or it may have the option to redeem (i.e.: purchase) a shareholder’s stock. On the other hand, if the corporation is unable or unwilling to exercise the option, the agreement might also permit the remaining shareholders the option to purchase the stock.

A Cross-Purchase Agreement is an agreement among the shareholders themselves! The Agreement provides (upon specified events), that shareholders are either required (or, they may have the option) to purchase the stock of another shareholder. For example, a cross-purchase agreement might be utilized to purchase stock upon the death of a shareholder!

Essentially, Stockholders Agreements provide for transfer restrictions and they act as a “buffer” against unwanted third party involvement in a corporation. The logic is that the original shareholders have a “chemistry” among themselves that will end if outside third parties become involved in the business. Accordingly, contractual restrictions are deemed necessary to protect that “chemistry”.

There are many other nuances to Stockholders Agreements (e.g.: provision allowing mechanism for resolving disputes short of corporate dissolution, etc.) beyond the scope of this article. We recommend that all corporations with multiple shareholders consider the adoption of a “Stockholders Agreement”. Stockholders Agreements are an essential element of good corporate maintenance.

Please telephone or email me should you have any questions or if I may assist you in preparing a Stockholders Agreement.

Thank you.

Leslie E. Chayo, Attorney at Law

Telephone 310.277.6337
Email chayolaw@aol.com
Law Offices of Leslie E. Chayo
9401 Wilshire Boulevard, Suite 1250
Beverly Hills, California 90212

Moshe’s comment – Mr. Chayo is an excellent lawyer and a deal maker. We have worked with him on many transactions involving buying and selling car dealerships. His law practice has a strong focus on car dealers. Mr. Chayo is highly recommended by us, should you need an attorney when considering buying or selling an auto dealership.