In the case described below, decided last week by the Minnesota Supreme Court, minority shareholders in a closely held corporation were, in their view, swindled out of value when their shares in the company were rendered “fractional shares” via a “reverse stock split” and then, in their view, their interest in the company was forcibly “redeemed” (i.e., they were forced to surrender their interest in exchange for payment) at a “deflated” or artificially low price. (This process is described in more detail below.)
The trial court, intermediate appellate court, and the Minnesota Supreme Court all held that this was outside of the courts’ province to set right.
Update (April 14, 2011): This week, Peter Gleekel from Winthrop & Weinstine and Bill Pentolovitch from Maslon Borman Edelman and Brand put the thorny issues in the Cold Spring case in stark detail before the Minnesota Supreme Court (absent Justice Stras, who recused himself).
In a nutshell, are minority shareholders under Minnesota’s corporate statute without any remedy in the event of a freeze-out absent their ability to show fraud under Section 423 (“A determination by the board of the fair value of fractions of a share is conclusive in the absence of fraud”) or, under some circumstances, may they challenge such a maneuver under Section 751 as “unfairly prejudicial” and get a judicial determination of the value of their fractional shares? (Either way, how does one harmonize the two statutes?)
This one is too close to call but the Justices seemed unanimous that the Minnesota Business Corporation Act is very “pro Board” (that is, favoring the board of directors at the expense of minority shareholders). There may be a consensus that any imbalance is something for legislative rather than judicial rectification though time will tell.
Original Post, Sept. 16, 2010: Imagine a company’s six shareholders (let’s call them A, B, C, D, E, and F) holding 100 shares divided 20, 20, 20, 20, 10, 10. Now imagine that A, B, C, and D (who happen to hold a majority of shares) decide that they want to change the number of shares, converting 20 shares to one share. In other words, the shares would then be divided: 1, 1, 1, 1, 0.5, and 0.5, respectively.
E and F, as owners of the 0.5 “fractional shares,” have no rights to veto the reverse stock split under the shareholders’ agreement, and under the plan they will be forced to “redeem” their fractional shares involuntarily (in other words, may be forced to sell their shares). Can this be done under Minnesota corporate law? If so, how are those fractional shares to be valued? The Minnesota Court of Appeals (Worke, Lansing, Stauber) in an opinion by Judge Worke dealt with this issue in U.S. Bank, N.A. v. Cold Spring Granite Company.
Pat Shriver, Minnesota corporate lawyer: “Minnesota’s Business Corporations Act permits corporations to redeem fractional shares amounting to less than 20 percent of a series, with the directors determining the fair value of the fractional shares. The board’s determination is conclusive in the absence of fraud.”
The Cold Spring Granite Company hired locally well-known business appraiser Art Cobb to value the shares and assign a value to the fractional shares, with the value subsequently ratified by the board. Stearns County District Court Judge Elizabeth A. Hayden assigned the case to a special master who found the reverse stock split and redemption of resulting fractional shares was permitted by the Minnesota Business Corporation Act. And although the special master made different valuation findings ($1,142.92/share rather than $986.50/share as Cobb had found), the court adopted the special master’s recommendations that the board-determined value was not fraudulent and denied the shareholders’ request for relief.
The appellants/former fractional shareholders had hoped for a judicial valuation under Minnesota corporate law for dissenters’ rights or judicial intervention under MBCA section 751. The Court of Appeals recognized that the facts of the case were similar to those in which Minnesota law provided such remedies, but not similar enough. “Despite our concerns….we are bound to apply the law as written.”
Pat Shriver concludes:
This case is notable for corporations and minority shareholders alike. Corporations may be attracted by the possibility of ‘freezing out’ minority shareholders holding less than 20% of a particular series of corporate stock without adissenters’ rights proceeding. Minority shareholders may want to negotiate a limitation on the ability of the corporation to consummate a reverse stock split or to redeem minority shares if they do a reverse stock split.