Minority Shareholder in Closely-Held Farming Corporation Had No Reasonable Expectations that Majority Could Violate – Case Dismissed
Baur v. Baur Farms, Inc., No. EQCV 032201 (Madison County, IA District Court, Jul. 29, 2014), on remand from 832 N.W.2d 663 (Iowa 2013)
Read the district court's opinion here: 2014 07 31 findings of fact conclusions of law and order (01902804x9D4A5).pdf.
In a case of major significance to estate and business planning for closely-held corporations in Iowa, particularly farm corporations, the Iowa Supreme Court found that a minority shareholder of a family farm “C” corporation could be “oppressed” (which could lead to a liquidation of the corporation) even though the controlling shareholders had not breached any fiduciary duties in the course of operating the corporation. We wrote extensively on the case shortly after the decision was released.
The case was remanded to the trial court for a determination of oppression under the “reasonable expectations theory.” As we noted in our earlier article, “…the Court’s decision is seriously flawed in numerous respects and it is not at all unlikely that the trial court could determine (even using the “reasonable expectations theory”) that the corporation did not engage in oppressive conduct and that the minority shareholder’s expectations in this case were unreasonable” [page 8]. That is precisely the outcome of the trial court’s remand decision.
In our earlier article, we noted that the Supreme Court had mischaracterized the facts that it had before it which supported the notion that the minority shareholder’s reasonable expectations had been violated. The trial court pointed this out on remand by stating, “Certain of this Court’s findings of fact are different from facts recited by the supreme court.”
Note: The trial court, on remand, noted that the Supreme Court’s decision was not the law of the case because of the differing facts. The trial court cited United Fire and Casualty Co v. Iowa District Court for Sioux County, 612 N.W.2d 101 (Iowa 2000) for that proposition.
The Supreme Court also noted that the record it reviewed was truncated and had not been adequately developed and, thus, the Court couldn’t apply its “reasonable expectations standard” but that the facts should be fully developed on remand. Those facts have now been fully developed.
In our earlier article, we noted that the facts of the case did not support a finding that the minority shareholder had any reasonable expectations that the controlling shareholders had violated. While the Supreme Court said that, “every shareholder [even minority shareholders] may reasonably expect to share proportionally in a corporation’s gains…”, we pointed out that such a standard ignores the reality of how closely-held businesses function and could actually amount to oppression of the majority. The basic problem with the Supreme Court’s opinion was that the court announced its “reasonable expectations theory” without ever determining (as the trial court put it on remand) whether the minority shareholder’s “articulated expectations in the present case were reasonable.” The Supreme Court simply stated that oppression existed when the majority shareholders “having the corporate financial resources to do so, … [pay] no return on shareholder equity while declining the minority shareholders [sic] repeated offers to sell shares for fair value.”
Also in our article, we set forth just exactly what the reasonable expectations of a minority shareholder in a closely-held farming operation are: (1) that the corporation will likely never pay a dividend; (2) that the minority shareholder will not be able to participate in management; and (3) that the value of the minority shareholder’s interest will be discounted on buy-out to reflect the fact that it is a minority interest and that the buy-out price will also include a discount to reflect the tax imposed on the corporation due to the buy-out of the minority shareholder. [p. 6] We also pointed out that the minority shareholder received his entire stock interest in the corporation by gift and inheritance, and never worked in the farming business a day in his life. As such, he hadn’t committed any capital to the family farming operation and “the sole source of his equity was the result of the investment of others and corporate retained earnings which were the result of others in profitably running the farming operation.” 
The trial court’s remand decision was detailed on all of these points, with the trial court first pointing out that the Iowa Supreme Court “did not determine whether Jack’s [the minority shareholder] articulated expectations in the present case were reasonable.” That was largely the point of our detailed article in 2013 – there cannot be a violation of a minority shareholder’s reasonable expectations if the minority shareholder didn’t have reasonable expectations!
Here’s a blow-by blow breakdown of the trial court’s conclusions of law on remand:
- On the fact that the minority shareholder received all of his shares via gift and inheritance, the trial court noted that “courts have noted that the donor’s wishes [here, that the farm stay in the family and be operated by family members so long as a family member wished to farm] have some bearing on whether the donee’s expectations are reasonable and that the donee’s expectations ‘as they evolve over the life of the enterprise’ also shape expectations that courts will credit.” Thus, the trial court concluded, “Objectively viewed, Jack could not have had his present expectations [to force a liquidation of the corporation upon buy-out of his interest] when he received the gifted stock. Any such expectations would be unreasonable and not founded in objective reality.”
- The court noted that expectations are only reasonable if they are made known to the other shareholders and that Jack could not reasonably expect to redeem his shares for a price that did not take into account the bylaw restrictions (which he drafted), the expectations of the other shareholders, and the impact of redemption of his interest on the corporation and the other shareholders. On this point, the trial court noted that Jack never announced his expectation to redeem his stock for more than what would be calculated under the bylaws until many years after the bylaws were adopted, and that he had no reasonable expectation that a different methodology would be used. Other shareholders, the trial court noted, would not have supported the 1984 bylaw amendment had they known of Jack’s expectation.
- On the issue of redemption of Jack’s shares without regard to the impact on the corporation or the rights of other shareholders, the trial court determined that the other shareholders would have every right to be treated the same as Jack upon redemption of their shares, and that Jack’s contrary expectations were not concurred in by the other shareholders and were not reasonable.
- On the fact that the corporation didn’t pay dividends, the trial court noted that Jack admitted that he never requested that the corporation pay dividends and that he acknowledged that it is not a good idea for farm corporations like Baur Farms to pay dividends.
- The trial court noted that Jack made no capital investment in the corporation at any time and that his redemption rights are subject to the 1984 bylaws.
- On the negotiations surrounding an attempted buy-out, the trial court noted that the parties never reached an impasse due to the majority shareholders insisting on a minority discount for Jack’s shares. In addition, the trial court noted that buying Jack out at the amounts he identified in the 1992-1996 negotiations or in his 2007 offer, would have been oppressive to the other shareholders. In addition, the trial court noted that the corporation’s last offer did not include a minority interest discount and was substantially more than the liquidated value of Jack’s stock based on market value figures.
- The trial court also determined that the corporation’s insistence on a discount for built-in gains on liquidation (unreduced to present value) was not unreasonable. On this point, the trial court found the corporation’s expert witness testimony to be persuasive. The trial court noted that Jack repeatedly sought liquidation of the corporation at corporate board meetings (he was a board member), and that if the corporation were to be liquidated (the statutory remedy if Jack were to establish oppression) he would receive net liquidation value – which would reflect the after-tax value of his interest.
- The trial court held that the fair value of Jack’s shares under the Iowa Supreme Court’s standard did not exceed the amount of his proportionate share of the market value of the corporation’s assets, discounted to liquidation value, and that the $430,000 final offer the corporation made in 1996 was based on the fair market value of the corporation’s assets and exceeded Jack’s proportionate share of the corporation’s liquidated value at that time.
The trial court concluded that Jack made demands that exceeded the fair value of his equity interest in the corporation. Accordingly, Jack failed to prove oppression by a preponderance of the evidence.
The trial court’s remand decision is welcome relief for closely-held corporations in Iowa from an Iowa Supreme Court decision that is out-of-step with reality. To find, as the Iowa Supreme Court did, that there can be shareholder oppression (with the likely result of corporate liquidation) where there isn’t even an allegation of a breach of fiduciary duties by the controlling shareholders would result in, as the trial court’s remand decision points out, oppression of the majority and could also result in corporate liquidation anytime a minority shareholder wants to “cash-out” for personal gain (as in the present case). The trial court’s decision also upholds the use of bylaws that set forth stock valuation upon buy-out. In this case, the Iowa Supreme Court allowed the minority shareholder to ignore the bylaw setting forth the valuation methodology for a buy-out (which he drafted), but the trial court held him to it. That’s more welcome news for closely-held corporations.
It remains to be seen whether the minority shareholder will seek review of the trial court’s remand decision. But, given the large amount in controversy, that might be likely.
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