The Forced Buy-Out: Lessons From Sound Infiniti
Posted Sep 2, 2020
By Washington State Business and Real Estate Lawyer David C. Tingstad
In this week’s blog, I review the classic Washington Supreme Court decision, Sound Infiniti, Inc. v. Snyder, 169 Wn.2d 199, 237 P.3d 241 (2010), which stands for one simple proposition: majority shareholders who follow the statutory rules may successful force out the interest of a minority shareholder – even over the objection of the minority shareholder.
Dissatisfaction at the Dealership
Richard Snyder, David Hannah, and Afshin Pisheyar formed Sound Infiniti, Inc. (“Sound Infiniti”) in the early 2000s to operate an Infiniti automobile dealership. Snyder had a 30 percent share, Hannah had a 51 percent share, and Pisheyar had a 19 percent share in Sound Infiniti. Hannah and Snyder were involved in management, but Pisheyar had no such role. In 2003, the three men found a fourth partner, Robert Curtis, and the four men formed another corporation, Infiniti of Tacoma at Fife, Inc. (“Infiniti of Tacoma”), with the percentage ownerships staying largely unchanged from Sound Infiniti, but for Curtis taking a 5 percent share and Hannah dropping to a 25 percent share. The roles in management were also unchanged.
In 2004, Pisheyar’s relationship with Hannah and Snyder went south as Pisheyar wanted a greater role in management of the dealerships. Hannah and Snyder refused to give Pisheyar what he wanted, and Pisheyar filed suit against Snyder and Hannah, alleging both individual and derivative harm.
Reverse Stock Split
In response to Pisheyar’s lawsuit, Snyder and Hannah voted to amend Sound Infiniti’s articles of incorporation to implement a reverse stock split. The reverse stock split reduced the corporation’s shares from 100 to 4. As Pisheyar no longer owned a full share, Snyder and Hannah decided to exchange Pisheyar’s shares for a cash payout. Significantly, Snyder and Hannah also did the same thing for Pisheyar’s shares in Infiniti of Tacoma. Not surprisingly, Pisheyar objected.
The buyouts terminated Pisheyar’s shareholder status in the corporations, and thereby relieved him of any standing to bring lawsuits against Snyder and Hannah. In a sense, the reverse stock split served to get rid of Pisheyar and his lawsuit.
In this instance, Sound Infiniti and Infiniti of Tacoma used the reverse stock split by way of an amendment to the articles of incorporation, which had the effect of reducing Pisheyar’s share of stock to a fractional share. In accordance with RCW 23B.06.040(a)(a), a corporation has a right to redeem fractional shares. Additionally, a corporation may“[e]ffect a reverse split of the corporation’s outstanding shares and the number of authorized shares of that class in the same proportions. RCW 23B.10.020(4)(b).
Despite Pisheyar’s arguments that the reverse stock split was wrongful, the Supreme Court responded that Washington’s Business Corporations Act (the “WBCA”) is very clear: reverse stock splits are allowed in Washington:
There is no allegation here that the majority shareholders deceived Pisheyar about the reverse stock split, that they provided him with a proportionately small number of shares, or that anything was procedurally wrong with the reverse stock split transaction itself. Pisheyar merely alleges that the majority shareholders wished to be rid of him and froze him out against his wishes. These actions, however, are expressly allowed by Washington law and are not fraudulent by any definition.
Sound Infiniti, 169 Wn.2d at 210.
Under the WCBA, Pisheyar’s sole remedy against the stock split was to “dissent” and proceed with a fair value appraisal proceeding under RCW 23B.13. As Pisheyar was no longer a shareholder, his individual claims were dismissed by the trial court and affirmed by the Supreme Court as the fair value proceeding under the dissenter’s rights statute, RCW 23B.13 et seq., displaced Pisheyar’s claims as his exclusive remedy.
Sound Infiniti highlights the importance of following the rules, whether contractual or statutory. Snyder and Hannah ultimately prevailed because they used the tools available to them within the articles of incorporation and the WCBA. Failure to follow the contractual or statutory steps would have proved fatal to both Snyder’s and Hannah’s efforts to remove Pisheyar as a shareholder.
Furthermore, this case highlights the need for sound legal counsel at the beginning of a business venture. Consideration of these issues at the outset may have permitted Pisheyar to protect his minority interest from the apparent oppression of the majority. Perhaps Pisheyar could have negotiated a shareholder agreement to protect his minority interest from the whims of the majority.
A reverse stock split and other fundamental changes to a corporation such as a merger can be used to eliminate the interest of minority owners. The beginning of a business venture is the most important time for those holding a minority interest in closely held companies to protect their interest when the relationship between owners becomes strained.
The relationships and interests of owners in closely held entities change over time. Minority interests in closely held corporations or LLCs have little value, unless care is taken to protect those interests. Every business is unique as is the interest held by each owner. Care must be taken at every step to preserve value and control.
For more Washington business entity law considerations, refer to this blog every Wednesday at 12 PM, noon.
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