Ashley Geary, Esq.
Update on Minority Shareholders' Dissenters Rights
Updated: Jun 21, 2022
In early July 2018, we posted a brief article regarding a minority shareholder’s right to dissent to a private equity (“PE”) deal and force the corporation or the other shareholders to purchase his/her shares in lieu of going along with the deal. In that article, among other things, we raised the issue of how a court would appraise the value of the minority shareholder’s shares and whether the court would take into account the purchase price offered by the PE company. In other words, if a shareholder exercised his/her right under the law to have his/her shares redeemed by the group rather than participate in the PE deal, at what price would the group be required to purchase those shares? Would a court or arbitrator look to the group’s internal buy-out agreements to determine value? Would they look to the PE price as indicia of value? Would they rely on a third party appraisal? We also raised the issue that, in addition to financial considerations, dissenting shareholders must take into account the impact, if any, that the merger will have on their restrictive covenant. Although these issues have not been addressed at the national level, one recent Colorado appeals court decision suggests that: (1) the PE offer may not be relied upon to determine the fair value of the shares, but (2) a non-compete agreement may be deemed unenforceable if the dissenting shareholder was forced to cease employment with the practice as a result of his/her dissent.
Fair Value of Shares
In Crocker v. Greater Colorado Anesthesia, P.C. (2018), the Colorado Court of Appeals held that the purchase price offered by U.S. Anesthesia Partners (“USAP”) to acquire the assets of Greater Colorado Anesthesia, P.C. (“GCA”) did not reflect the fair value of Dr. Crocker’s (the dissenting shareholder) shares. In reaching this decision, the court relied on: (1) the statutory definition of “fair value” in a dissenters’ rights action and (2) the basis for USAP’s purchase price calculation. Although the statutory definition will vary by state, a number of states define fair value similarly to Colorado - “the value of the shares immediately before the effective date of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action except to the extent that exclusion would be inequitable.” CO Rev. Stat. s. 7-113-101(4) (emphasis added). Accordingly, at least in those states having a statutory definition similar to that of Colorado, courts may look to the Crocker decision and hold that fair value is determined BEFORE the PE deal closes.
In determining whether the USAP amount offered to GCA shareholders was an adequate representation of the fair value of the shares BEFORE the merger-acquisition took effect, the court looked at what exactly USAP was getting in exchange for such purchase price. The court found that USAP was not merely compensating the shareholders for the value of their shares. Rather, USAP was also compensating the shareholders for their willingness to enter into new employment agreements with a 5-year commitment and a 21.3% reduction in compensation. Accordingly, the purchase price was significantly inflated and could not be relied upon to determine the value of a dissenting shareholder’s shares where such shareholder was not tied to an employment commitment and did not face a significant reduction in compensation. Because most PE deals require a significant employment commitment and a reduction in compensation, this case provides courts around the country with some guidance as to whether to rely on the PE offer in determining the fair value to be paid to a dissenting shareholder.
Enforceability of Non-Compete
Although the Colorado court did not grant Dr. Crocker the benefit of the PE purchase price as fair value for his shares, the court did hold that the non-compete provision in his employment agreement with GCA was unenforceable as a result of Dr. Crocker’s exercising his right to dissent to the merger.
The Colorado court acknowledged that, generally speaking, a non-compete would survive a merger with the right to enforce such non-compete vesting in the surviving entity. However, in this case, Dr. Crocker’s exercise of his dissenter’s rights resulted not only in his loss of shareholdership in GCA, but also his employment with GCA because the agreements did not permit him to remain an employee of GCA without also remaining a shareholder. Accordingly, if the non-compete were enforceable, Dr. Crocker would be forced to choose between his statutory right to dissent to GCA’s merger and his ability to continue practicing (and living) in the area. As the court stated, the intention of dissenter’s rights is to protect minority shareholders from oppression by the majority. Rather than protecting him from majority action, enforcement of the non-compete against Dr. Crocker would penalize him for exercising those rights. For this and other reasons, the court deemed the non-compete to be unenforceable against Dr. Crocker.
Based on this case, minority shareholders must consider the impact of dissenting to a PE deal, both from a financial standpoint and a practical standpoint. Although, based on the Colorado case, minority shareholders should not expect to receive the same financial pay out should they choose to dissent to a merger, there is a possibility that such dissent may invalidate their restrictive covenant. Given the long-term employment commitment typically expected from PE companies, the ability to get out of a non-compete may be more lucrative to some physicians than receiving the additional compensation.