Case of the Missing Shareholder Agreement

Missing Shareholder AgreementsSavvy business people should know better.  But, sometimes they just don’t. And, so it was in Ritchie v. Rupe; a case decided by the Texas Supreme Court in late June 2014 involving the contentious redemption of a deceased shareholder’s interest in a closely held business that neglected to draft a shareholder agreement.  The Rupe case tells a cautionary tale for the accounting industry where firms often operate without adequate partnership agreements – or none at all.

The facts in Ritchie v. Rupe are complex; but here is a distilled version.  Rupe Investment Company (“RIC”) is a Dallas based investment banking firm with a history dating back to the early part of the 20th century.  Ann Rupe is the widow of Dallas Gordon Rupe III (a.k.a. “Buddy”), the son of founder Dallas Gordon Rupe, Sr.  Ann inherited Buddy’s 18% interest in RIC.  The other two shareholders include Buddy’s sister, Paula, and Lee Ritchie, whose father was also a founder of RIC.  Together Paula and Ritchie controlled 82% of the shares.  Despite the sophistication and size of RIC, no shareholder agreement existed.  Apparently Paula and Ann never really got along, and things worsened after Buddy’s passing.  Ann approached Paula and Ritchie and asked that her interest be redeemed. Although the book value of Ann’s shares was $3.7M, RIC offered Ann $1.8M, allegedly based on how RIC had previously valued shares. Clearly disappointed, Ann decided to sell her shares to an outside buyer.  Paula and Ritchie refused to meet with any prospects making it nearly impossible for Ann to dispose of her interest.  Ann sued Paula and Ritchie for engaging in illegal oppressive behavior against a minority shareholder.  A jury awarded Ann $7.3M, which was later affirmed by the Court of Appeals at Dallas.  The Texas Supreme Court, however, reversed Ann’s award; and, after nearly a decade of very costly litigation, sent Ann back to essentially where she started with Paula and Ritchie.

Although the Supreme Court empathized with Ann’s difficult situation, it concluded that Ritchie and Paula had no contractual obligation to value Ann’s shares using any particular formula, or to meet with prospective buyers.  The Court stated that “shareholders of closely held corporations may address and resolve such difficulties by entering into shareholder agreements containing buy-sell, first refusal or redemption provisions.”  The Court went on to say that “by definition a closely held corporation is owned by a small number of shareholders whose shares are not publicly traded;” and emphasized the importance of an agreement for the disposition of a shareholder’s interest.  Finally, the justices noted that the shareholders of a closely held corporation often “enjoy personal relationships as friends or family members in addition to their business relationship;” suggesting that these life-long connections are a poor substitute for a comprehensive shareholder agreement.

The facts in Rupe are commonplace in the accounting industry.  Many smaller firms either lack partnership agreements or their existing agreements are seriously flawed.  Partners in accounting firms cannot rely on past relationships or the law to fashion acceptable resolutions to difficult partnership issues; such as the departure of a member through retirement, resignation, death or disability.  Partners must guarantee their own safekeeping by way of a robust and tailored partnership agreement that is periodically reviewed and updated to reflect the current conditions of the firm, the industry and the law.  It is a key succession planning and transition imperative.  In the absence of a proper agreement, unnecessary ambiguity, disappointment, conflict, and the potential for expensive and time consuming litigation are all likely to prevail.  While there may never be a great time to author or update the firm’s partnership agreement; clearly the worst time is when it’s too late.

See related briefings here:

Who Would Run Your Firm? Practice Continuation Agreements.

Is Your Buy-Sell Agreement Up To Date?

What Happens When an Owner Dies Without a Buy-Sell Agreement?